(Bloomberg Opinion) -- “As I see it, Europe is at an Alexander Hamilton moment, but there’s no Alexander Hamilton in sight.” That witticism came from Paul Volcker, a former chairman of the U.S. Federal Reserve, when he was visiting the European Union in 2012, in the throes of the euro crisis. Volcker, who died in 2019, nailed it — and for the EU in 2020 just as in 2012.
Volcker was referring to a controversy about “euro bonds,” as they were called then, which has now resurfaced under the label (what else?) “coronabonds.” The circumstances are different — a sovereign debt crisis then, a pandemic now — but the idea is the same.
The euro area would raise new debt for which all 19 members of the currency union would be jointly and severally liable. Countries such as Italy and Spain, which are suffering the most from the coronavirus, would get cheaper access to the money they need to recover. States like Germany, which currently borrow at negative rates, would pay only trivially higher interest costs. What better way to finally show European solidarity?
If only it were that easy. As it stands, only nine members of the euro area support coronabonds. That leaves 10 unconvinced. Germany is among them, of course. The bluntest rejection has come from the Dutch.
That has infuriated many southerners. A group of Italian politicians this week took out a full-page ad in a German newspaper, accusing the Dutch of “a lack of ethics and solidarity,” and unsubtly reminding the Germans of the solidarity Europe showed them after the war, when Germany’s debts were forgiven or restructured at a conference in 1953.
So tempers are boiling once again. As indeed they were in 1790, when intellectual titans including Alexander Hamilton and Thomas Jefferson had a similar debate, the one Volcker had in mind. Hamilton, America’s first treasury secretary, wanted to assume the debts of the 13 states that had recently joined together to fight off the Brits. Jefferson and his followers were against the idea, fearing that the federal government would become a behemoth threatening the liberties of the states.
Both were right. The U.S. did assume the states’ debts, thus seeding today’s huge Treasury-bond market. And the federal government did balloon, as it took on ever more functions over time, especially after the New Deal of the 1930s. But the result was the United States of America as we know it.
So what European dilemma was Volcker putting his finger on with his analogy? Since it started in the 1950s, the European project also aimed, at least in theory, to become a United States of Europe, as implied in the phrase “ever closer union.” Currency union was a big step in that direction. To work, it now requires full banking, capital-markets and fiscal unions. European bonds to rival U.S. Treasuries would seem like the way to go.
The devil’s in the differences. Hamilton cleanly took the debts from the states and transferred them to a different entity, the federal government. That same entity was simultaneously handed the power to raise tax revenues to repay its new debt. In this role it was given legitimacy by having the people’s and states’ representatives in Congress deciding those taxes.
Moreover, the U.S. from that point on stuck to a much more ruthless form of Europe’s “no-bailout” rule. The federal government has never rescued a state, letting several go bankrupt in the 1840s. The states understood they were fiscally on their own, and all but Vermont eventually gave themselves balanced-budget rules not unlike Germany’s. In turn, the federal government took on functions such as fiscal policy to manage aggregate demand.
By contrast, the thinking behind euro bonds had totally different origins. As originally envisioned, they would still be issued by the member states but guaranteed by all countries in the euro area. In effect, this would be like California selling debt and all 50 U.S. states vouching for it. How enthusiastic would the Texans be about that? And how delighted would the Californians be when the Texans show up in Sacramento to tell them how to cut the Golden State’s budget? Now swap in Italians for Californians and Germans for Texans, and you get the idea.
The proposals for euro bonds kept changing subsequently (this overview counts at least eight versions). But no matter the design, they kept that crucial divergence from Hamilton’s clean cut. The most prominent idea is to divide the debt of member states into two tranches, blue bonds worth up to 60% of each nation’s GDP and red bonds for everything in excess. The blue bonds would be “mutualized,” perhaps jointly issued and certainly guaranteed by all, and thus be rated AAA. The red bonds would be junior and lack the common liability, and rated lower.
But the tax revenues to repay the bonds would still be harvested by the individual member states, and national legislatures would still decide how to tax and spend. Unsurprisingly, the Dutch, Germans, Austrians and Finns, among others, fear that the southern parliaments may just tax too little and spend too much, knowing that in a pinch the northern tax euros will repay their creditors. Academics call this “moral hazard.” To mitigate it, the north would insist on more rigid fiscal rules, but Rome and Madrid wouldn’t be happy about those. It’s Texans and Californians again.
Here, then, are two of the many ways in which the euro area, and perhaps the whole EU, could blow up in the coming generation. In the first scenario, the north obstinately balks at all forms of “mutual” debt issuance. Southerners, resenting this lack of solidarity, turn to nationalist and Brussels-bashing populists like Italy’s Matteo Salvini, who take their countries out of the euro and maybe out of the EU, possibly accepting cash from China instead, or whichever new friend they can find.
In the second scenario, the north agrees to mutualized debt, starting with coronabonds and then expanding from there. But the south is humiliated by the austerity rules imposed from Brussels once the conoravirus depression is over. And northerners settle on the narrative of the dreaded “transfer union,” in which their hard-earned tax euros flow into the bottomless pit of the Mezziogiorno. Now it’s the north that turns to nationalist and Brussels-bashing populists and leaves the EU.
So what’s needed is indeed Hamilton bonds. Europe must take that historic step and issue bonds, levy direct taxes, and vote on all of this at the top — meaning federal — level. In effect, the euro area needs a government, with a treasurer and a legislature, which could be a subgroup of the European Parliament. It could start small, but over time would have to take roles from the states (like unemployment insurance, say).
All this would require changes in Europe’s treaties and, more importantly, minds. Just as it did in Hamilton’s time. But maybe that’s the ultimate difference: The Americans in 1790 really did want a United States, whereas the Europeans of 2020 don’t. If Volcker were around, he would repeat: There’s no European Hamilton in sight. Unfortunately, this means that the EU only has bad options.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Andreas Kluth is a member of Bloomberg's editorial board. He was previously editor in chief of Handelsblatt Global and a writer for the Economist.
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