Eurobonds key to financial stability: Nobel economist
There’s no other way. In order for Europe to hold together as a monetary union it must be able to issue a currency region-wide bond. That’s according to Christopher Sims, Nobel-prize winning economist and Princeton University professor, speaking on a panel at the IMF over the weekend:
My view is that the only way to preserve the usual manner of operation of monetary policy in Europe, and the usual operation of financial institutions is to deliver on the Eurobond, and not after years but soon. A Eurobond that could be used as the main instrument of monetary policy in Europe would go a long way to stabilizing the financial system.
This explains why Europe is in trouble while other industrialized nations that also face high debt levels are not seeing anywhere near the same market pressures, Sims said:
There is a very important distinction between inflation risk and default risk. There is a kind of a default premium. An entity that issues debt that only promises to pay paper that it can print for free, is free of any risk that the entity will be unable to deliver on the contract terms. It’s one thing for markets to worry about unpredictable inflation reducing the value of a bond. Another thing is for the markets to be uncertain whether at the next rollover this issue of debt is going to not be fully paid or whether there might be a general haircut on debt.
The risks to holders of debt of an unspecified form of default is much more disruptive than the risk of losing some of the value of the debt through unpredictable inflation. And I think that’s why even though on fundamentals the UK and the U.S. and Japan look like they’re in as much trouble as European countries, nonetheless those countries can print what they promised to pay. So there’s no short-term risk of a sudden, unpredictable allocation of losses across different bondholders.
It makes sense. Yet given the complicated political challenges posed by the issuance of a common bond across separate nations, Europe better hope Sims has it wrong.
Risks from ECB debt drip
The abundance of European Central Bank liquidity in the euro zone financial system is making for smoother issuance of shorter-dated debt in the euro zone.
Case in point: Spain. This week the country sold double its previously announced target of three- and four-year government bonds amid solid demand.
But there are risks, particularly if the Treasuries of lower-rated countries get too comfortable issuing at the short-end of the curve. Michael Leister, strategist at DZ Bank, described the potential pitfalls in a telephone interview:
As easy and as attractive it is for the Treasuries to tap these shorter maturities at the moment … obviously this also has a downside in that the average maturity of the debt is decreasing and that builds up a substantial rollover risk because all this short-term debt will become due in a couple of years.
Although you can find a lot of arguments why the situation will be better in say 2-3 years time, it reminds us of the same story back three years ago when the financial crisis kicked off and the Treasuries increasingly went for the shorter maturity to bridge these market tensions. But now we have been living with these market tensions for three, four years.
So indeed rollover risks are building up and the average maturity profile is shortening.
