It is becoming increasingly clear that Mrs Merkel is not going to end this current Euro-zone debt crisis until she gets a water-tight commitment from the Euro-zone countries to bring their budget deficits and debt levels down.  This is why Germany wants lending to be channeled through the EFSF and/or the IMF – because these institutions will attach conditions to their loans, conditions which joint euro-bonds would lack.  For the time being it suits Germany to let the bond markets drive the cost of borrowing higher across the Euro-zone because this is applying intense pressure to force other euro-zone countries to allow the Troika (ECB, IMF & EFSF) to monitor their budgets.

Once Mrs Merkel gets what she wants (i.e. only after countries are nailed down to bringing their budgets into balance) then maybe the ECB will print money via the backdoor of lending to the EFSF (which gets turned into a AAA-rated bank that borrows from the ECB to finance the purchase of sovereign debt) or it lends to the IMF (which has years of practice at playing hardball with countries, forcing them to cut their budget deficits in return for emergency loans).

The biggest problem with joint Euro-bonds is the lack of leverage over euro-zone members who do not play by the rules.  The answer to the question of just how do you enforce budgetary discipline on wayward countries is to force them to accept Troika monitoring of their budgets when they have to go to the EFSF for help because the bond markets have shut them out.  Slowly over time (likely to be one or two decades) those Euro-zone countries which cannot run their budgets properly will end up relying on the EFSF for all their funding, their domestic bond markets will shrink in size and the EFSF will in effect be issuing joint Euro-bonds.  But Germany can and will borrow cheaper in her own name (the respected Ifo Institute has calculated otherwise it would cost Germany €47 bln every year in higher debt interest payments).

Ireland, Portugal and Greece (if it stays in the Euro) will never wean themselves off the EFSF because they will never be able to borrow as cheaply as the EFSF can.  The EFSF is in fact the thin end of the joint euro-bond wedge and the EFSF will in the fullness of time come to be seen as a key benefit of euro-membership (at the price of submitting your budget to the Troika for annual approval).

Joint euro-bonds are not a workable solution to the euro-area’s current sovereign debt problems.  As drawn-out and painful as it is going to be, the only long-term solution is to regain the confidence of the bond markets via a combination of lower budget deficits (preferably balanced budgets), positive nominal GDP growth AND a sustainable debt burden.  i.e. Go back to the Stability & Growth Pact rules (3% budget deficit and debt capped at 60% of GDP) and make sure they are adhered to this time and enforced by requiring each euro-zone country’s budget to be approved annually by the Troika. 

The EFSF is about as close as we are realistically going to get to joint euro-bonds for the foreseeable future but all of this pre-supposes the EFSF will be able to find buyers for its bonds.  The EFSF will have an eye-watering amount of debt to sell to investors and will need to gain their confidence.  The risk is France loses its AAA-rating which undermines the EFSF’s own rating – just watch the gold price spike if that happens! 

Hence the difference between joint euro-bonds and the EFSF is that strong countries will be able to finance themselves more cheaply outside the EFSF whilst everyone else will end up using the EFSF (but they will only get money if their budgets meet with approval each year).