Merkel: Just Say Nein to Eurobonds

By MATTHEW WILL, WSJ

The European financial crisis has created an unusual mix of allies. Politicians, hedge fund managers, liberal pundits and the financial press are determined to convince German Chancellor Angela Merkel that economic salvation requires the European Central Bank to issue eurobonds.

Prior to last week's European Union summit in Brussels, the Organization for Economic Cooperation and Development endorsed French President Francois Hollande's plan to do just that and insisted Mrs. Merkel agree. She wouldn't, but at the summit she was all but held captive until relenting to some other bailout.

Meanwhile, money managers have waged their own campaign to get Mrs. Merkel on board. Financier George Soros has predicted dire consequences for Europe if Germany does not acquiesce. Harvard historian Niall Ferguson accused Mrs. Merkel of repeating the mistakes of Weimar Germany that led to the collapse of democracy. He did not use the "N word," but we all know an appeal to German guilt when we see one.

Each faction has its own reason for pressuring Germany but all share a common characteristic: They are wrong.

Historically, nations tax, borrow and spend until there is nothing left to tax and borrow. Because of the risk of riot, insurrection or removal from office, politicians refuse to directly cut spending. Instead, they print money. Unfortunately, the citizenry does not realize printing money and the ensuing inflation amount to a cut in benefits. Then politicians lay the blame for inflation on greedy capitalists who raise prices.

Europe's bad boys have played this trick repeatedly, undermining the value of their currency and reducing their citizens' standard of living. From 1980 to the launch of the euro in January 1999, the Italian lira and Portuguese escudo lost 108% and 244% of their value against the U.S. dollar, respectively. Greece devalued the drachma 583% against the dollar from 1981 until its euro entry in January 2001. Meanwhile, the deutsche mark remained remarkably stable against the dollar, gaining a mere 1.74% over 20 years.

Now the people borrowing and spending the money, such as Greece, Italy and Portugal, are not the same people controlling the money supply. This is handled by the European Central Bank, whose policies Germany monitors closely. When spendaholics reach their tax and borrow limits they can no longer print money. Thus the violent convulsions reverberating through countries that must face the music.

Until now, investors saw socialist calls for more borrowing and more spending as ridiculous, since no one will loan them money. The only reason private investors now care is because they were recently forced to take a 70% loss on Greek government bonds.

Then came the stroke of genius that united the forces of socialism and capitalism: Allow the profligate nations such as Greece, Italy, Portugal, etc., to borrow and spend, but require Germany to pay back the loans.

In its November 2011 Green Paper, the European Commission proposed that each eurozone member be fully liable for the entire issuance of eurobonds. Germany, with the highest GDP and good credit, has the most to lose from such an approach.

Therein lies the common ground between investors looking to save their own portfolios and politicians looking to spend their way into office. Who cares what happens to Germany and the other responsible nations?

Unfortunately, the long-term consequence of this approach will be global economic chaos. In the past, patterns of taxing, borrowing, spending and the printing of money destroyed local economies. These collapses occurred over time, and the impact was isolated. If Germany assumes the ultimate obligation of paying the debt of other nations, the bubble grows. When Europe gets to the point of collapse, who will guarantee that debt?

Eventually, money will be printed and the standard of living will fall for citizens of irresponsible nations. This is a historical reality. The only real question is, do we prefer that the entire European bubble burst at once, or mitigate the risk by allowing local bubbles to burst periodically over time? The best possible answer is for Angela Merkel to just say nein to more eurobonds.

Mr. Will is professor of finance at the University of Indianapolis.