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Single euro zone bond needs to come back to table

A picture taken 28 June 2005 shows a giant Euro symbol, the currency of the EU, standing in front of Frankfurt's Eurotower, which houses the European Central Bank (ECB).

John MacDougall/AFP/Getty Images/John MacDougall/AFP/Getty Images

Buried for more than six months by squabbling euro zone policymakers, the idea of a single euro government bond may need to be dug up as one of the few logical solutions to the bloc's worsening sovereign debt crisis.

Countless attempts this year at ringfencing the crisis in the bloc's debt-strapped periphery nations of Greece, Ireland and Portugal look to be failing as creditor nerves spread to giant Italian and Spanish bond markets in a sharp escalation of the problem over the past week.

Whatever the merits of speculation against either Spain or Italy, the growing contagion goes beyond the raw numbers on debt sustainability and comes more as a vote of no-confidence in the bloc's ability to address the euro's fundamental design flaws.

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What is clear to most experts is piecemeal bailouts and hastily-agreed rescue funds or support mechanisms that characterize the political response to date are unlikely to be sufficient in scope or size to cope with infection of the larger debt markets.

The prospect of funding problems in Italy - which has the biggest euro government debt pile in absolute terms - would be a hammer blow to the single currency project, whose aims included building a deep and liquid benchmark debt market to rival that of the U.S. Treasury.

If euro zone governments and peers in the Group of 20 global economic powers are serious about repeated commitments to the single currency, it will be hard to avoid for long the politically thorny issue of a unified bond market or debt agency.

"Neither the euro area nor possibly the rest of the world can afford a full-blown Italian bond market crisis," said Jim O'Neill, Chairman of Goldman Sachs Asset Management (GSAM) and advocate of a move to a single bond.

"The broader concern is we are still waiting for some sort of true leadership out of Europe."

The single bond proposal put to governments last year, supported by euro group chairman Jean-Claude Juncker and initially at least by the French and Italians, was originated by economists Jacques Delpla and Jakob Von Weizsacker at Brussels think-tank Breugel - of which GSAM's Mr. O'Neill is a board member.

The idea, an update of which was commissioned by the European Parliament again in March, involves splitting sovereign debt in the euro area into two parts - "blue" and "red" bonds.

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The former would be a senior tranche of debt issued by all euro countries for debt stock up to 60 per cent of output, pooled among members and jointly guaranteed to ensure a super AAA credit rating - or "AAAA" as the authors put it.

Red bonds would then be junior debt issued above the 60 per cent limit. That would be the sole responsibility of the issuing country and where likely higher borrowing costs for most countries would provide a major incentive to curb excess debts.

The added rider is a new pool of top-rated bonds in a world with a severe shortage of triple-A securities for the likes of pension funds and central bank reserve managers. The scale of the blue bond market at up to €6-trillion would be just shy of the U.S. Treasury market, Breugel estimates.

This feature, advocates argue, could push yields even lower than existing German Bunds - overcoming one of Berlin's concerns about assuming higher borrowing costs for guaranteeing more profligate neighbours. Breugel says overall it could save up to 10 per cent in net present value of debt servicing costs.

Some feel the plan should never have left the policy table.

"If Eurobonds had not been rejected, not only would they have avoided attacks from the markets and contagion to other members, but they would have attracted many large AAA sovereign debt international investors heavily exposed to dollar treasury bonds, achieving a perfect hedge," Guillermo de la Dehesa, Chair of the Centre for Economic Policy Research said in a recent paper.

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Objections to the proposal, flatly rejected by Germany for undermining the euro's 'no bailout' principle, are also hard to fathom following three national bailouts and "quasi-Eurobond" guarantees implicit in this year's European Financial Stability Fund and future Europe Stability Mechanism, Mr. de la Dehesa argued.

What is more, soft support for some central bond or debt agency has risen despite German attempts to kill it last year.

European Central Bank board member Lorenzo Bini Smaghi said last week that euro zone members should let a supranational body issue their debt up to certain limits.

And perhaps a more telling line on the need to think radically about further euro integration rather than the prospect of breaking up the union came last month from ECB chief Jean-Claude Trichet.

"In this Union of tomorrow ... would it be too bold, in the economic field, with a single market and a single central bank, to envisage a ministry of finance of the Union?" he asked What were considered long-term musings even a month ago, however, have assumed a different level of urgency as the crisis now makes its way to the heart of monetary union.

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