Europe requires European bonds

by Christophe Chamley

Vox
January 10, 2012

Is it time for Eurobonds? This column argues that Eurobonds have always been the right solution. Every successful union throughout history has needed to create a proper financial instrument of sovereign debt – and the Eurozone is no different.

The ongoing Eurozone crisis has at least four dimensions:

• Divergent labour costs between countries
• Reluctance to embrace fiscal sharing,
• Seemingly high levels of some sovereign debts, and
• Self-fulfilling high interest rates on some sovereign bonds that may lead to default.

Eurobonds have been proposed as a tool to address the last issue. Although these have been discussed for more than two years, during which the crisis has worsened, no progress has been made, perhaps because the idea seems too new, and because of the ambiguity of political positions. Yet the creation of a new instrument of public debt is not a new problem in history, and past experiences provide clear lessons.

There is no example in history of the rise of a political power without the simultaneous creation of its proper financial instrument of sovereign debt. The creation of a new financial instrument rests only on one basis, its credibility. For each of the past creations, that credibility was based on a central principle: the alignment between bondholders and both the tax revenues used to service the debt and the funding of the new debt. In other words, specified taxes were levied on which the service of the debt had first claim.

This principle was at work in the Italian cities of the Middle Age, in the 16th century Castile of Philip II, in the Dutch republic of the late 16th and 17th centuries, in England after the Glorious Revolution, and in the foundation of the US. In 18th-century France, the limited use of that enforcement mechanism may have contributed to the fiscal problem of the Ancien Régime that led to the French Revolution. All these countries had to start anew to establish mechanisms for a new financial instrument of the public debt. The same challenge faces European countries today.

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