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Pressure grows for adoption of euro zone bonds

Growing calls for the introduction of euro zone bonds is ratcheting up pressure on Europe's dominant power – Germany – to reconsider this oft-rejected response to the continent's crippling debt crisis.

German officials insist the topic is off the table at Tuesday's much-anticipated meeting in Paris between Chancellor Angela Merkel and French President Nicolas Sarkozy to discuss the financial turmoil.

But many experts and prominent European officials – even within Germany – say pooling the combined borrowing power of all euro zone members may ultimately be the only way to save the common currency. Doing so, however, would mean a fundamental transfer of budget power to Brussels plus potentially divisive constitutional battles in several member countries. And most critically, the move would have to overcome the visceral opposition of Ms. Merkel herself.

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The European Central Bank revealed Monday the steep cost of relieving interest rate pressure on Italy, Spain and other indebted member countries. The central bank spent a record €22-billion ($31-billion) last week scooping up sovereign bonds as it struggled to halt the spread of the debt crisis. It was the most the ECB has spent in any week since it launched a bond-buying campaign in May.

In recent weeks, nervous investors have triggered spasms of contagion across Europe. Fears that France, Europe's No. 2 economy, may be next has convinced many experts that only a common debt regime will convince investors that the euro zone can survive and prosper.

The chief benefit of euro zone bonds would be to make it affordable for countries facing debt pressures, such as Italy and Spain, to borrow money.

The downside is that it could push up borrowing costs in financially strong Germany, which now boasts the euro zone's lowest rates.

On Monday, one of Germany's leading economic associations broke ranks by backing the idea of euro zone bonds. Anton Boerner, president of Germany's BGA export association, acknowledged that all other avenues for fighting the crisis have been exhausted.

"The alternative is the markets attack Italy, then France, we lose our triple-A rating and then it's our turn. This is a downward spiral that would lead to a worldwide depression," Mr. Boerner told Reuters.

"We'll end up paying three times over. This way we pay just once."

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Germany's trade association for small and mid-sized companies echoed the endorsement, pointing out that euro bonds could be introduced with guarantees to limit German liability.

The leader of Germany's official opposition, the Social Democratic Party, has also offered a conditional nod to the idea of euro zone bonds. Even top Merkel government officials aren't entirely ruling out the possibility.

And billionaire investor George Soros called on Germany to make it happen and lead Europe out of crisis.

"There is only one choice," Mr. Soros told Der Spiegel in an interview posted on the German magazine's website Monday. "If [the euro] were to break apart, all hell would break loose . . . To make it work, you have got to allow the members of the euro zone to be able to refinance the bulk of their debt on reasonable terms. So you need this dirty word, 'euro bonds.' "

Mr. Soros added that the creation of the bonds would have to be in tandem with strict new fiscal rules to ensure the solvency of all euro zone members – a structure that would make the move less distasteful to German voters.

The euro zone's fiscal rules have long been a weak link in the common currency as member countries, such as Greece, veered dangerously off their prescribed course.

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Analysts also warned that the creation of euro zone bonds would mark a profound change, forever shifting control of member countries' budgets to Brussels. And it would likely require potentially contentious constitutional amendments in Germany and elsewhere.

"An introduction of a euro bond would make it necessary to change the constitution of several countries, including Germany, and would require at the least a further change of the institutional set up of the euro zone with more oversight and control from Brussels," said German-based Goldman Sachs economist Dirk Schumacher.

Last week's ECB intervention has at least temporarily eased pressure on Italy and Spain, Europe's third- and fourth-largest economies. Yields on both countries' bonds have fallen to roughly 5 per cent after flirting last week with the dangerous 7 per cent threshold – a level that would prove painful for both countries to bear over the long haul.

The bond purchases also move the euro zone closer to the kind of fiscal union that would be required for the introduction of euro bonds, argued Ed Yardeni, president and chief investment strategist at Yardeni Research Inc.

"The ECB is forcing a de facto fiscal union on the euro zone by supporting the bonds of debt-challenged member countries only if they re-establish fiscal discipline," Mr. Yardeni pointed out.

Compounding Europe's debt woes is the continent's slowing economy. And investors will get a sense Tuesday of just how sluggish it is when the European Commission releases its estimate of second-quarter gross domestic product in both the euro zone and the wider European Union, which also includes Britain.

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About the Author
National Business Correspondent

Barrie McKenna is correspondent and columnist in The Globe and Mail's Ottawa bureau. From 1997 until 2010, he covered Washington from The Globe's bureau in the U.S. capital. During his U.S. posting, he traveled widely, filing stories from more than 30 states. Mr. McKenna has also been a frequent visitor to Japan and South Korea on reporting assignments. More

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