Sovereign debt should be a matter of willingness to pay, not ability to pay. Government tax revenues are constrained not by the potential tax revenue of their society, but by the tax revenue that they can extract from an unwilling population.
This isn’t a corporate financing problem that can be reduced to getting more revenue and cutting expenditure. It’s a political problem. Investors must ask themselves whether governments can stick to austerity programmes or raise taxes against opposition. The mysterious quality of credibility must be maintained.
With this in mind, surely it is questionable whether a fiscal deal can ever be struck that would be acceptable to European electorates? There is, after all, no way to sidle into fiscal union and pretend it isn’t happening.
The way in which the common currency is structured guarantees that monetary policy will be inappropriate in large parts of the eurozone at any given time. The only way to tackle this would be fiscal transfer. In simple terms, making the euro work with its present membership means that rich Northern Europe needs to commit to pay for Southern Europe.
These transfers will need to be fast and large. They will be effective in proportion to their size – they can’t be stealth transfers or funnelled in by the back door. Germans will need to become materially poorer so that Italians can benefit – just as London’s taxes are higher than it wants or needs, in part to pay for a large public sector in more deprived areas of the country.
The size of the problem means any settlement will only be as good as the next political cycle.
Merkel and Sarkozy could agree an unconditional guarantee of everything under the sun, but even if they get it past domestic opposition in the short term, such a settlement cannot bind their successors for long.
For as long as eurozone member states remain sovereign in the sense that Liverpool, for example, is not, a durable settlement based on mutual guarantees or fiscal transfer is impossible. It will always be vulnerable to the sovereignty of the country that is on the hook for the cash. Domestic politicians in a democracy will always feel more obligation to their own electorate than to their far-off European fellows.
So investors will always have to be open to the risk that the next political change means the disintegration of whatever guarantee and transfer system ends up in place. Friday’s plan – whatever it is – might firm up a few T-bill auctions. But it cannot provide a solid foundation for term issuance.