Hamish McRae: Europeans have a right to feel cheated

The turmoil of the eurozone continues, with this week already proving a particularly difficult one. The immediate issue is that the second bailout of Greece seems to be faltering even before it is in place. The longer-term one is nothing less than the future of the eurozone, for the decisions taken now will help shape the way it develops.

The Greek issue is at its heart very simple. The price of bonds issued by the Greek government has fallen so much that debt issued with a coupon of 6.25 per cent was yesterday yielding more than 19 per cent. In effect, investors are saying that they believe Greek debt is worth between half and one-third of its face value, for if it were worth more, any buyer would stand to make a huge profit when it was redeemed. But under the terms of the bailout, as proposed, holders of Greek debt would get back most of their money. So the markets are saying the deal is dead.

Of course markets get things wrong. They got things spectacularly wrong when they bought all that Greek debt three or four years ago. But their judgement matters now because Greece, and the other weaker eurozone nations have to be able to fund themselves on the public markets. They cannot rely forever on loans from the rest of the EU.

This simple point – that the individual countries have to be able to borrow on their own guarantee – is at the core of the eurozone as present constituted. The proposal being kicked around that there should be an issue of so-called "eurobonds" would change that. These would be bonds guaranteed by the eurozone members as a whole, in proportion to their size.

Hamish McRae

Prominent Economist and Futurist

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So Germany as the largest economy would guarantee something like 30 per cent of the loan while France would do another 20 per cent.

In theory such bonds would not be quite as good as a true German bond, or even a French one, but issuing these would help fund the countries that are either unable to borrow from the markets or can only do so at prohibitive rates.

There are, however, grave problems with this. One is that Germany would be stretching its creditworthiness, adding to the notional debts of the German state itself, already more than 80 per cent of GDP, a touch higher than the UK. Another is that in exchange for guaranteeing the bond the strong countries would need to have some sort of say over the ways the money was being deployed: they would in effect have to run the finances of the weaker ones.

Another is the arithmetic of Europe. Germany and France are large enough to be able to guarantee Greece and Portugal. But were Spain and Italy to need to finance themselves with central funds, even Germany and France might not be strong enough to do so. There has already been talk of France losing its AAA status should it have to extend a guarantee of this nature.