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The Globe and Mail

Germany wants to have it both ways on euro bonds

Core countries of the euro zone – particularly Germany – are being hypocrites.

I recently wrote that it would be best for Greece to default on its debt obligations and leave the euro zone. This would be good, I argued, for Greece but bad for Europe.

Greece has already lost its economic sovereignty and is under economic occupation by the European Union, the International Monetary Fund and the European Central Bank. They have tried all kind of tricks to get Greece not to default. After all, it is Europe's major banks that will be on the hook if Greece defaults. They want Greece inside the euro zone, not outside.

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But is staying within the euro zone good for Greece? Greece has the lowest labour market efficiency of all major euro zone countries, according to National Bank Financial estimates. Greece simply is not competitive and if it stays within the euro zone it will continue to be uncompetitive and its debt obligations will continue to increase.

Greece's plight reflects a fundamental problem with the common currency. As currently structured, the euro is good only for the strong economies, because the value of the currency reflects the average competitiveness of the euro zone countries from the least competitive, Greece, to the most competitive, Germany. At its average value, the euro is undervalued for Germany and overvalued for Greece.

Germany benefits from this arrangement because the euro makes its products cheaper on international markets than they would be if the country still had its own national currency. The result is that Germany has been experiencing strong exports. With Greece, the problem is the opposite. The euro makes its products uncompetitive, so it has seen strong imports. Not surprisingly, the country from which Greece imports the most is Germany.

Now fast forward to the possible euro bond issue. The European Financial Stability Facility, set up last year by euro members to aid its weak members, is considering issuing euro bonds to raise money for "possible bailouts." These bonds will be guaranteed by all euro zone members. Euro bonds will replace sovereign bonds issued by individual euro zone countries.

The idea is that bonds backed by all euro zone members will be more difficult for speculators to attack than the bonds of a single country. The money raised through euro bonds will be divided between euro members and used to cover each country's needs.

Who are key supporters of the euro bonds idea? Weaker members like Italy and Greece. Who is the key opponent? Germany. Why? Because euro bonds will be valued at a price reflecting the average efficiency and risk of the euro countries. On average, euro bonds will be issued at yields higher than Germany would pay by itself but lower than Greece would pay on its own.

Greece will benefit from euro bonds at the expense of Germany, the same way as the average value of the euro benefits Germany at the expense of Greece. It is easy to see now why Germany does not like the idea. And that is why I think Germany is not playing fair – it wants the benefits, but it is not willing to accept the costs associated with this symbiotic relationship.

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In my opinion, the euro bond issue is an excellent idea whose time has come. It will make the euro zone more functional by offsetting some of the inherent biases that the euro has against weaker euro zone members.

In the end, however, I am afraid that Germany, as well as other core euro zone members, may decide to opt out of the common currency rather than share the costs. Here is the paradox: instead of seeing weaker members being ejected from the euro zone, as most people expect, stronger members may decide to walk away instead. One way or another, the euro zone may look quite different in the future.

George Athanassakos,, is a Professor of Finance and holds the Ben Graham Chair in Value Investing at the Richard Ivey School of Business, The University of Western Ontario.

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