Can euro bonds save the union?
Confirming Germany’s worst fears

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  • With the periphery sinking into deeper recession, what will be #Germany’s next move to solve the #Euro crisis?

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  • Can #Euro bonds save the union? Will #Merkel sign on?

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  • #Merkel will contemplate a move to a form of a federal fiscal union only once the periphery restores balance.

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Hope springs eternal among policy makers in Europe’s beleaguered periphery. At five minutes to midnight in Athens, and with a bank run having started in Madrid, these policy makers cling to the forlorn hope that somehow Germany is going to relent on its strong opposition to euro bonds. And they do so despite the deterioration in the economic and financial situation of the periphery, which is now validating Germany's worst fears about the potential costs to Germany of signing up to a scheme that would effectively involve a German guarantee of sovereign borrowing in the European periphery.

Underpinning Germany’s strong antipathy to euro bond issuance is the concern about the damage that such bonds could inflict on Germany’s creditworthiness and the fear that such bonds could induce even more irresponsible behavior in the periphery. If the Italian, Portuguese and Spanish governments could all borrow at effectively the same rate as Germany, what incentive would there be for them to correct their public finances? And if they did not correct their public finances, would not the cost of Germany’s guaranteeing those bonds raise Germany’s borrowing costs as well?

Two weeks ago, Germany’s chancellor, Angela Merkel, was handed a resounding electoral defeat in North Rhine-Westphalia, Germany’s largest state, on voter unhappiness about the way she has handled the euro crisis. It is little wonder then that Merkel has insisted that Germany will contemplate a move to some form of federal fiscal union only once the countries in the European periphery have demonstrated that they can restore balance to their highly compromised public finances, along the lines of the fiscal pact reached at the December 2011 European summit talks.

The chances of that occurring anytime soon are close to zero, especially with the periphery sinking ever deeper into recession and with a political backlash against austerity. One would think that by now policy makers in the periphery should be busying themselves preparing for the almost inevitable Greek exit from the euro within the next few months.

Desmond Lachman is a Resident Fellow at the American Enterprise Institute.

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