The Blanchard/Ubide Eurobond Proposal suggests converting 25% of each EU member state's GDP into jointly issued "blue bonds," backed by individual rather than joint guarantees, without requiring treaty change. While the timing appears opportune due to US policy uncertainty, a weakening dollar, surging European defense spending, and growing appetite for integration, the proposal contains serious structural flaws.
Key Concerns:
- Lack of Mutual Guarantee: The proposal lacks joint and several guarantees, which are prohibited by TFEU Article 125. This results in a lower credit rating (AA+) for blue bonds compared to German国债, making them less likely to become a benchmark safe asset.
- Risk Concentration: Reducing risk in blue bonds concentrates it in the remaining national bonds, creating a convex crisis dynamic where yields spike sharply during stress periods.
- Market Fragmentation: The proposal would disrupt repo markets and reduce liquidity, exacerbating issues during crises.
- Scale Insufficiency: The proposed blue bond market (€5 trillion) is only about 1/6 the size of the US Treasury market, making it unlikely to challenge the dollar's dominance.
- Moral Hazard: High-debt countries might expand their deficits, viewing the plan as a way to shift debt burdens to more prudent nations.
Market Implications:
- Yields: Blue bonds would likely have yields higher than German国债 due to the lack of mutualization and higher risk in red bonds.
- Liquidity: The reduced supply of German国债 and the lower liquidity of blue bonds could lead to significant repo market disruptions during crises.
- Market Structure: The proposal would create a deeper but less liquid market compared to the US, with potential for fragmentation between blue and red bonds.
Long-Term Risks:
- 特洛伊木马 Effect: The plan could become a "Trojan horse," incentivizing further debt issuance as red bond crises increase pressure for blue bond expansion.
- Fiscal Union: Without a fiscal union and centralized fiscal control, the proposal risks moral hazard and fiscal irresponsibility among member states.
Recommendations:
- Address TFEU Article 125 directly.
- Clarify crisis and default arrangements.
- Implement mechanisms to avoid partial default.
- Develop a clear long-term plan for debt mutualization.
- Establish a "no expansion" clause.
- Address adverse incentives for increased issuance.
- Compensate prudent countries for lower liquidity and higher yields.
Conclusion: The current proposal is unlikely to gain traction due to its structural flaws and the lack of a supporting fiscal union. Significant reforms are needed to address moral hazard, risk concentration, and market liquidity issues before the plan can be successfully implemented.
