LONDON, June 9 (Reuters) - Investors warily eyeing U.S.

Treasuries may be tempted to turn to jointly-backed European

bonds instead, but there's just not enough of this 'risk-free'

alternative. Building scale and depth will be Europe's biggest

challenge.

Some transformative ideas are re-surfacing, however.

Given investors' concerns about being heavily overweight in

U.S. stocks, bonds and the dollar at a time when American policy

is creating global economic upheaval, Europe appears to have a

rare moment of opportunity to attract badly needed investment

capital - much of it from its own savers - to reboot its

long-lagging economy.

For many, including European Central Bank economists and

policymakers, that push should involve the expansion of a 'safe'

investment base of sovereign bonds jointly issued by euro

members, overcoming the investment headaches created by

fragmented national government bond markets.

Jointly issued debt was long resisted by Germany and others

for fear that countries with higher debt loads would piggyback

off of more fiscally frugal countries. But then the Rubicon was

crossed with the sale of joint euro bonds as part of the

post-pandemic regional regeneration.

The problem is there's simply not enough of this debt to

provide a deep and liquid home for the world's biggest

investment funds, both in Europe and abroad. Even after the sale

of all the so-called 'Next Generation EU' bonds and other joint

instruments issued by the European Investment Bank or European

Stability Mechanism, the total is still just over a trillion

euros.

But Germany's position on debt-funded stimulus and European

defense integration has shifted dramatically this year, even if

Berlin is not yet totally on board with widely expanded joint

debt. In turn, proposals have emerged for a new push on euro

bonds.

A paper penned by former International Monetary Fund chief

economist Olivier Blanchard and Citadel adviser Angel Ubide last

week offered a detailed plan. It proposes switching national

debt worth up to a quarter of each member country's GDP for

jointly guaranteed and more senior 'blue' euro bonds.

Described as a 'working document', the proposal published by

the Washington-based Peterson Institute riffs on over a decade

of ideas on how best to construct a common bond for euro

nations.

But instead of dwelling on the thorny issue of credit

sharing that dominated discussions during the euro debt crisis

over 10 years ago, it focuses instead on how to scale up the

market to offer a viable rival to U.S. Treasuries.

"Our belief, based on discussions with market participants,

is that exchanging national bonds for blue bonds up to 25% of

GDP may be enough for liquidity purposes and still not raise

issues about safety," Blanchard and Ubide wrote.

EURO ZONE 'BLUES'

A truly monumental change is needed here. There is currently

only around a trillion euros of joint EU debt outstanding, and

tentative proposals for joint debt to fund European re-armament

would not shift the dial much in terms of scale. Even the German

bund market at some 2.5 trillion euros still pales in comparison

against the $28 trillion U.S. Treasury market.

But Blanchard and Ubide's plan could initially generate

jointly issued debt with a total market value around 5 trillion

euros. This debt would then be replenished going forward, and

the market should grow with the development of a yield curve and

futures market as well as acceptance in ECB repurchase

agreements.

Multiple legal and operational questions were addressed by

the paper, including how the debts could be serviced centrally.

The authors calculated that the average cost of funding for

governments would remain the same on paper, with the attractive

features of the instruments eventually narrowing risk spreads.

One key issue to overcome is the treatment of the debt as

sovereign debt and not supranational debt, as most EU bonds are

currently categorized. Being classified as sovereign debt would

allow them to enter government bond indexes, thus expanding the

pool of locked-in investors.

What's more, the paper said that the proposed debt switch

would leave average debt-to-GDP at the euro zone level at around

60%, the benchmark under EU budget rules, compared to 87% last

year and about 100% in the United States. Even with the coming

increase in Germany's debt-to-GDP from its fiscal boost, the

ratio for the big four eurozone countries - France, Germany,

Italy, and Spain - would be left around 60% of GDP, according to

the authors' estimates.

"We know that large institutional changes, such as the

creation of a new financial instrument or a new market, always

entail risks and raises questions. But we are convinced that

doing nothing in the face of the large geostrategic shifts we

are experiencing would be much riskier."

However compelling the idea, such a complex operation still

seems daunting, even if Germany were to soften its position. And

the time needed to debate, design and implement the measure

would be lengthy.

Still, given the enormous capital demands needed for the

euro zone to regain competitiveness and the seismic changes

currently afoot in global trade, industrial policy and security,

these sorts of ambitious ideas should no longer be considered

pipe dreams.

The opinions expressed here are those of the author, a

columnist for Reuters.

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