"Establishing a Eurobond Market as an Alternative to U.S. Treasurys Has Become Urgent" - Peterson Institute

Yonhap News Agency

The United States, despite advocating for a rules-based international order, has failed to inspire confidence even among its allies, as U.S. President Donald Trump's repeated impulsive decisions have continued. Against this backdrop, there are increasing calls in Europe to establish a deep, large, and liquid Eurobond market.

Although the dollar still maintains its position as the world's key reserve currency, fissures have begun to appear due to factors such as the United States' excessive fiscal deficit. As a result, there is a growing argument that a well-functioning Eurobond market is needed to allow the euro to play a greater role, including offering an alternative to U.S. Treasuries. Currently, sovereign bonds are issued separately by each eurozone country. The core idea is to exchange part of the existing sovereign bonds for Eurobonds through buybacks, and to refinance maturing sovereign bonds with new Eurobond issuances.

Olivier Blanchard, Senior Fellow at the Peterson Institute for International Economics (PIIE) and former IMF Chief Economist (2008–2015), together with former Senior Fellow Angel Ubide, argued for the creation of a proper Eurobond market in an article titled "Eurobonds: Despite objections, they are more needed than ever" published on the PIIE website on May 7 (local time).

The following is a summary of their main arguments.

The urgency of establishing a deep, large, and liquid Eurobond market has grown

There are three reasons for this urgency. First is necessity. Europe must accelerate the development of strategic autonomy to respond to cracks in the rules-based global order. Disputes with the United States over Greenland and rising doubts about the future of the North Atlantic Treaty Organization (NATO) clearly demonstrate that Europe can no longer wait. Strategic autonomy requires three pillars: military power, economic power, and financial power. Safe assets are an essential condition for financial power. Europe cannot rely on U.S. Treasuries, which are foreign currency-denominated assets, as the pillar of safe assets for its own economy. While enhancing military and economic power is a process that takes many years, expanding the Eurobond market can deliver immediate results.

Second is opportunity. There is growing global demand for European assets as part of a strategy to diversify away from U.S. assets. Investors want to spread geopolitical risk, but Europe's fragmented bond markets do not sufficiently meet this demand for safe assets. The European Union (EU) has a sounder fiscal position than the United States, with lower debt and deficit ratios relative to GDP. However, the outstanding balance of sovereign bonds rated AA or higher is just under 50% of GDP in the EU, compared to over 100% in the U.S. Eurobonds, backed by Europe's stable rule of law and reliable institutions, would increase the supply of European safe assets and offer an attractive alternative to U.S. Treasuries.

Third is institutional support. The European Central Bank (ECB) is now actively promoting the international role of the euro as a prerequisite for achieving monetary sovereignty. Initiatives such as the digital euro and a repo market for non-euro area central banks are examples. As ECB Executive Board Member Piero Cipollone put it, "If we lose control over our own currency, we lose control over our economic destiny." Moreover, the euro cannot become a global international currency without a sufficient supply of safe assets to meet investor demand.

Clarification of our proposal

We propose that over the coming years, each EU member state should announce that up to 25% of its debt relative to GDP will be replaced with Eurobonds. This can be achieved through a combination of two actions: exchanging existing sovereign bonds for Eurobonds via buybacks, and refinancing maturing sovereign bonds with Eurobonds.

The principal and interest payments on these Eurobonds would be backed by transfers of member states' fiscal revenues, similar to current transfers to the EU budget, and stipulated in national law. At current interest rates, the necessary transfer would amount to about 1% of GDP. These transfers for Eurobond interest payments would replace the interest payments previously made directly on retired or redeemed sovereign bonds. Since Eurobond interest rates would likely be lower, this would result in net savings for member states. Eurobonds would benefit from dual guarantees: a legal commitment from the EU as issuer to repay the debt, and a political and legal commitment from member states to transfer the necessary resources for repayment.

We propose that the European Commission, on behalf of the European Union, issue EU-Bonds (bonds) and EU-Bills (bills) as the Eurobond instruments. These already exist at substantial scale and benefit from established infrastructures such as the repo and futures markets. By the end of 2026, the outstanding balance of EU-Bonds and EU-Bills will approach 1 trillion euros, making it the fifth largest after Germany, France, Italy, and Spain. Our proposal could include consolidating the issuance by other EU supranational bodies, such as the European Stability Mechanism (ESM), into EU-Bonds and EU-Bills, potentially expanding the market to 5 trillion euros.

Our proposal addresses the main weakness of existing Eurobonds. Current Eurobonds are classified as supranational, not sovereign, bonds. This reduces demand and is the main reason they yield higher returns than German Bunds. The legal status of being supranational rather than sovereign reduces demand for EU-Bonds and EU-Bills by up to 80% compared to similar sovereign bonds. This is solely due to their classification as "quasi-government" for legal purposes, not concerns about creditworthiness. In this context, it is crucial for the EU to signal stable issuance by deciding to refinance the EU-Bonds and EU-Bills issued to fund the post-COVID NextGenerationEU (NGEU) recovery program. By scaling up and establishing a predictable issuance program, our proposal would allow EU-Bonds and EU-Bills to be included in sovereign bond indices, significantly boosting global investor demand, lowering yields, and reducing risk.

A deep and liquid Eurobond market would also enable European banks to diversify their domestic risk and support the development of a deep and liquid European corporate bond market. This would contribute to the growth of a savings-investment union and lower the cost of public and private funding for all countries.

Clarification of what we are not proposing

We are not proposing Eurobonds as a means for some countries to circumvent clearly inadequate fiscal capacities and increase borrowing and spending. We are not proposing any new spending programs. We are only proposing to replace a portion of sovereign bonds with Eurobonds without increasing the total amount of EU debt.

We are not proposing to earmark these Eurobonds for specific spending programs. Our proposal is about optimizing debt management, not selecting spending priorities. This is, in fact, how national budgets operate: spending decisions are separate from funding decisions. By separating Eurobond issuance from new spending programs, we remove one of the motivations to increase deficits. Of course, if in the future EU leaders decide by consensus to launch new spending programs, including those for EU public goods, they could fund these through Eurobonds.

We are not proposing any new taxes to support these Eurobonds. Since we are not proposing increased spending, no new taxes are necessary. Support for Eurobonds would come, as with existing EU-Bonds and EU-Bills, from reallocating current national revenues to the EU.

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