Ben Chu: The challenge for the eurozone? It must find its Abraham Lincoln

Economic outlook: When the Christian Democrats hear the word eurobonds, all they see is hardworking Germans picking up the bills

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The Independent Online

The elegant Lincoln Memorial here in Washington is in many ways a monument to the agonies of nation building. An extract from the 16th American President's second inaugural address from 4 March 1865 is carved onto one of the inner walls of the Doric-style temple that stands at the end of the National Mall. In one of the finest pieces of oratory in American history, Abraham Lincoln expressed his thoughts on the origins of America's great civil war, which was then days from ending: "Both parties deprecated war, but one of them would make war rather than let the nation survive, and the other would accept war rather than let it perish, and the war came." Indeed it did. And it ended with the defeat of the breakaway Confederacy. The integrity of the union had been preserved at the price of some 700,000 lives.

And the rest is history. A united America, over the next century, with its massive resources (both natural and human) went on to become the most powerful nation in the world, a new imperium that eclipsed even the mighty British empire. That is why the International Monetary Fund met here in Washington over the weekend. In the wake of the Second World War, when the Fund was founded, there was nowhere else it could reasonably have made its home. If the Confederacy had prevailed in 1865, this meeting to discuss the condition of the global economy might have been held somewhere else. And the 20th century, America's century, might have belonged to some other nation. The fates of future empires sometimes depend on the outcome of agonising internal struggles.

Surprising as it might seem, some can see great imperial potential in a contemporary internal struggle: the eurozone sovereign debt crisis. The Bruegel Institute, a Brussels-based think tank, was the first organisation to do some serious thinking about how a European debt union, which many see as the only way to save the eurozone, could work. Bruegel's proposal is that the eurozone should agree to a collective guarantee of the borrowing of member nations worth up to 60 per cent of their individual annual national output. The purpose of the collective guarantee is to shield weaker members from the kind of market attack some are facing at the moment.

Any further borrowing that an individual nation wishes to undertake on top of this sum would be exempt from the collective guarantee. The eurozone-guaranteed bonds would be known as "blue bonds" and the rest would be known as "red bonds". Bruegel anticipates that the market price of most red bonds would be significantly lower than blue bonds and thus charged a higher interest rate by investors. This, the think-tank argues, would mean that nations could borrow freely up to a certain reasonable point, without being subject to a destabilising run on their debt in times of difficulty. But they would also have a powerful incentive not to borrow excessively since the price of doing so would automatically rise.

But here's where it becomes interesting. Bruegel points out that the overall value of the blue bond market (around €5,600bn or £4,887bn) would be almost as great as that of the US Treasury Bill market ($8,300bn or £5,363bn). Therein lies the potential. One of the objections of Germany to the idea of a common debt union is that it would result in a rise in German interest rates, as investors realised they were not buying rock-solid bunds, but also Greek, Irish and Portuguese debt.

However, Bruegel points out that German interest rates might not rise at all under eurobonds, and could even drop. Here's why. Central banks, sovereign wealth funds and large institutional investors value two things above all: safety and liquidity. US Treasury bonds provide both those things, which is why they are the most popular investment on the planet and the ultimate safe haven (apart from gold). The sovereign bonds of northern European nations are considered safe too, but the market is not as deep and therefore it is less liquid.

Eurobonds could change that. Collective European sovereign debt might become as popular as Treasury bonds. The eurozone could have the same "exorbitant privilege" of ultra-low borrowing costs as the US. With such a cushion in place, Greece and the rest of the struggling eurozone periphery could sort out their economies much more easily. And Germany and other fiscally strong eurozone nations could also reasonably demand that all nations in the debt union enact major structural economic reforms as the price of this guarantee. What Bruegel argues is that that European leaders should recognise this golden opportunity nestling in the ordure of this crisis. A closer fiscal union could not only resolve the crisis that threatens to tear the single currency apart, but could also liberate the currency bloc's global economic potential.

So what is the problem? The answer is politics. Angela Merkel's Christian Democrat Party and her coalition allies, the Free Democrats, are trenchantly opposed to any suggestion of a pan-European debt union. Whenever they hear the word eurobonds, all they see are hard-working Germans picking up the bills for lazy southern Europeans. Simple nationalism is reasserting itself too. Prominent German, Finnish and Dutch politicians do not want closer economic European integration, whatever the economic benefits.

So should the anti-eurobond Europeans be regarded as the equivalent of the Confederates defeated by Lincoln; a reactionary force, standing in the way of the glorious march of history? In one obvious sense, the comparison is offensive nonsense. The states of the Confederacy were fighting for their "right" to enslave other human beings. The anti-eurobond Germans and other northern Europeans simply do not like the idea of a European super state. And it is by no means clear the people of the eurozone are in favour of closer fiscal integration.

Yet there are echoes nonetheless. The civil war was, to some extent, a conflict about where the appropriate balance lay between the rights of individual states and the power of the federal government. The battle over eurobonds is a struggle between the autonomy of European nations and the needs of the eurozone as a whole. Two sides with fundamentally different views of how the world does (and should) work are pitted against each other.

The stakes are high too. There will be a great economic price if the eurozone undergoes a disorderly unravelling, something that the prevarication of European politicians is bringing closer by the day. Research by Stephane Deo of the Swiss bank, UBS, suggests that the cost of a break-up of the eurozone for weak countries could be 40-50 per cent of GDP in the first year. And even for a strong country such as Germany it could be 20-25 per cent of annual output.

That's not equal to the cost of a civil war, but it would be traumatic nonetheless. Yet these potential costs have still not been spelled out to the European public. Politicians have failed to communicate what exactly is at stake.

They have been silent over the potential prize too. And that is the biggest difference of all in these parallel tales of nation building: Europe has yet to find its Lincoln.

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