Merkel Describes Eurobonds as “Wrong Answer”

In an interview earlier today on German television, Chancellor Angela Merkel expressed her clearest opposition to date against the concept of a “eurobond”. The use of a eurobond – essentially a security backed by all the Eurozone economies – has been suggested as the means to raise capital to fight the European debt predicament. Merkel described the eurobond approach as “exactly the wrong answer” to solve the crisis.

“They lead us to a debt union and not a stability union,” Merkel said during the interview on German public television.

Because eurobonds would be backed by all Eurozone members including the two strongest economies of Germany and France, the cost to attract investors would be considerably less than debt backed by individual nations. For countries like Greece and Portugal which have suffered credit rating downgrades, the premium required to attract investors has increased dramatically. This premium represents an additional cost and remains a severe roadblock hampering efforts to recapitalize individual economies.

Earlier this month, Spain and Italy watched helplessly as the risk premium on their respective debt offerings rose to a record since the formation of the Eurozone. The spread difference for an Italian government 10-year bond climbed to 416 basis points (or 4.17 percent) over the benchmark German 10-year bond now trading in the range of 3.25 percent. The Spanish 10-year government bond jumped to a spread of 417 basis points.

French President Nicolas Sarkozy has also spoken out against the creation of a eurobond. Following an August 16th meeting with Merkel, Sarkozy described the formation of a eurobond as an ill-advised approach that would put “most stable countries of the Eurozone in grave danger”.

Given their hesitation to participate in the scheme, you can’t help but wonder if Merkel and Sarkozy have not already accepted that some form of default for a sovereign Eurozone member is inevitable. If that is the case, it may be the situation in Italy that led to the formation of this opinion.

Italy is the third largest economy in the Eurozone and is more than six times the economy of Greece as measured by GDP. So far, about 200 billion euros have been provided to Greece in emergency funding and even this level of commitment has not translated into an assurance that Greece can avoid bankruptcy. Image then, the pending quagmire facing Italy.

The Italian debt is estimated to be about 130 percent of the country’s GDP; this explains why Italy is now thought to be on the fast-track to its own financial meltdown. This may also explain why Merkel and Sarkozy are hesitant at this time to co-sign a loan for their southern neighbor.