Coronavirus Crash - The Second Euro Crisis?

At the end of March, Ursula Von der Leyen delivered strong words in the plenary chamber of the European parliament which was almost empty due to contamination risks: “History is watching us. Let us do the right thing together – with one big heart, not 27 small ones.” The president of the Commission was responding to a shameful failure. In the days following the outbreak of the pandemic in Europe – the most significant crisis since the Second World War – there were no perceptible signs of solidarity among the Union’s member states. Government leaders essentially managed the crisis as if it were purely national; as though viruses in our interconnected societies would stop at hastily closed borders.

At the end of March, when the Italian ambassador to the EU requested protective masks for his country, which had been severely impacted, he received nothing but refusals. Germany, for instance, had in the meantime banned their export. Other Europeans, after all, had other concerns. Nevertheless, China, who hopes to integrate Italy into its Belt and Road Initiative, had already delivered them with much media fanfare. During these precious days Europe not only failed in human and political terms, but also in geostrategic terms.

Since then, calls for solidarity from all corners of Europe have increased. However, even though European governments agree that this crisis is a “test” for the EU (Angela Merkel), the form that a European response should take remains controversial. Within the eurozone, even after several video conferences, there are still strong differences of opinion, especially when it comes to disagreements over the sharing of financial risks with eurozone countries for which “corona bonds” are vital. Until now, neither the continent’s citizens or feverish financial markets have seen any sign of unity. This represents an imminent danger and could turn a number of Europeans away from the EU.

The coronavirus crisis now threatens to become a second euro crisis, which would be more difficult to overcome than the first one - if it even was. Ten years ago, the first euro crisis was above all due to political failures. In 2010, the absence of rapid and united action in response to Greece’s financial woes created tension on the financial markets. These problems spread to other southern European countries, creating a threat for the entire eurozone and the European Union. At that time, Italy and Spain were already in the crosshairs. Their economies, undermined by the recession, could not be protected from collapse by European loans due to their size as the two countries occupied the 3^rd and 4^th position in the eurozone. The situation did not calm down– if not from a political standpoint, then from an economic standpoint – until the autumn of 2012 when Mario Draghi, at that time the governor of the European Central Bank (ECB), announced his intention to buy bonds, on an unlimited basis, from euro member countries in crisis.

This was because the loan conditions imposed largely by Germany – a policy of radical austerity with dramatic social consequences – had driven a wedge between the countries in the eurozone, leading to Greece’s unsuccessful rebellion in 2015. The harmful political divisions from those years can still be felt and are determining the different reactions to the coronavirus crisis. The simple fact that, since 2015, the eurozone has not created any institution to lead a common economic and financial policy is wreaking havoc. Instead of disagreements between countries, a European finance minister for example – an idea proposed by France and blocked by Germany – could present a pan-European solution and thereby open a debate on economic policy.

This strongly highlights a fundamental, unresolved conflict. For the German and Dutch governments, economic crises would not be due to structural defects in Europe, but to political and moral failure in the countries concerned. The volatility of southern European countries is said to be at the source of the over-indebtedness of Greece or Italy. As a consequence, even in cases of extreme urgency, they refuse to be guarantors for their neighbors. Their traditional argument is that those who take on financial risk must also have oversight. The Dutch finance minister, Wopke Hoekstra, recently expressed this argument in blunt terms. The Christian Democrat requested an investigation in order to shed light on the lack of preparation for the pandemic in certain southern European countries.

It is therefore not surprising that a number of countries in southern Europe consider the current debate on the limits of European solidarity to be inhumane and petty while they face high death tolls in their countries. The Spanish prime minister’s angry outburst during a video conference with EU government leaders that Angela Merkel attended is revealing: “Do you not understand the emergency that we are going through?”. Sanchez and others are demanding a strong sign to prove that the countries in the eurozone are not just settling for being in the same boat, but that they are also united with their neighbors.

Sharing the Burden

This sign would be the implementation of “corona bonds” – which Berlin and The Hague both oppose –in conjunction with lines of credit dedicated to businesses and financing partial unemployment. Nine southern and western European countries – such as Belgium, Luxembourg, and especially France – are vehemently demanding them. These “corona bonds” would allow euro zone countries to issue common bonds backed by Germany’s solvency and thus benefit from advantageous interest rates. Currently, euro zone countries with heavy debt burdens, such as Italy, must bear interest rates that are much higher than Germany’s when they borrow on markets.

These “spreads”, as they are known, have begun to rise due to the growing nervousness of investors who are anticipating the disproportionate interest rates that Italy will have to bear. Exorbitant reconstruction costs await Rome. For the Financial Times, “without a way to pool risk across all euro members, investors will be forced to focus on the financial risk each country is taking on to fight the pandemic.”  In the worst-case scenario, rate differences will increase as long as countries like Italy are not able to borrow enough to deal with this crisis. They will therefore fall victim to an unending crisis.

This is why the idea to put in place credit financed by the European Stability Mechanism (ESM) put forth by Berlin and The Hague would not work. The European Stability Mechanism (ESM) resulted from the euro crisis and is for this reason considered to be an emergency instrument for financial markets. According to Doris Neuberger, an economist specialized in financial markets, “Any country which requests it now is inevitably considered a candidate for collapse.”

It is even more true that the ESM’s means are not enough to offset higher reconstruction costs. In addition, the ECB is already granting credit to the countries concerned. What these countries now need are “financial transfers”, as business economist Michael Hüther rightly points out. They would allow governments to make billions in investments that the economies ravaged by the pandemic need without raising their debt and significantly weakening their economies. The creation of European bonds would be the most effective solution.

They would allow eurozone countries to secure credit together at low rates that they would share amongst each other to help with the greater needs of countries such as Italy and Spain. Such sharing is crucial in order for this solution to be effective and the same would apply if the funds were raised within the framework of an expanded European budget (stimulus funds could also be financed by communal loans). Above all, everyone would benefit from sharing the costs and the euro zone would remain stable.

This would be valuable for not only economic reasons, but for political ones as well, which is especially the case for Italy. The country, a founding member of the EU, found itself at the epicenter (outside of Asia) of the pandemic. Day after day it was confronted by the horrors of triaging the sick in hospitals, doctors and health care workers infected by the virus, and burials carried out without friends or relatives. The country is also economically and politically vulnerable; Italy is in its third recession since 2008, when the global economic crisis began, and has a debt ratio of 135%.

Add to all that the fact that Italy, under pressure from Brussels, was forced to reduce its spending, most notably in the health care sector. Between 2009 and 2017, more than 46,000 jobs were cut, reducing the number of nurses to 5.8 per thousand residents. In Germany, this number is 12.9. Hospitals in Italy are also worse equipped than their neighbors in the north. At the beginning of the pandemic, Germany had 33.9 intensive care unit beds available for every 100,000 residents versus 8.6 in Italy. These cuts are often perceived in Italy as a German diktat and are therefore the root of many peoples’ anger: “First, Germany imposes austerity on us, then they don’t want to send us masks, and to top it all off, they reject corona bonds.”

La Lega, the far right party of Matteo Salvini, is doing everything it can to stir up this anger and exploit it. Although Salvini had been facing setbacks at the beginning of the pandemic, his criticisms of Prime Minister Giuseppe Conte being unwelcome, he is using Berlin and The Hague’s hard line as an instrument to create controversy and sow division as never before. According to him, ESM loans would be a “selling-off of our future”; yet another reason why they are considered “toxic” in his country. This is much easier for him than the humiliating treatment inflicted on Greece which, during the euro crisis, had to request loans under the ESM from European creditors and third party countries.

This is still so present in the minds of Italians that it allows Mr. Salvini to successfully stir up fear of a foreign stranglehold on the economy. For political reasons, Mr. Conte is also lobbying in favor of “corona bonds”. The future of his country in the European Union is far from guaranteed. Since the euro crisis, skepticism towards a single currency has gained momentum in Italy – and both Berlin and The Hague have greatly contributed to amplifying this. Meanwhile, 49% of Italians favor their country leaving the European Union, versus 29% in March. Contrary to the ultimately stabilizing effect of Brexit, an Italian exit would be difficult for the euro and European Union to manage. Salvini, whose La Lega party remains at the top of polls, has raised the idea of an exit referendum several times. If he wins in the next elections, that warning could become reality.

A mortal threat

The warning made by Jacques Delors, today 94 years old, for which “the lack of European solidarity” would represent “a mortal threat to the Union” is not to be taken lightly. Even if this poll is just one example, it is likely that these negative dynamics will continue, especially if the recession, mass unemployment, and the fear of losses persist. The inflexibility of Mrs. Merkel and her Dutch counterpart, Mark Rutte, is even more detrimental. Mrs. Merkel is concerned with the rejection of “corona bonds” in conservative spheres and those parties aligning with the far right AfD party  – and with good reason. However, even if in Germany the obsession with responsibility and austerity is appropriate, the debate is more open than ten years ago. Prominent politicians of the CDU party, such as Norbert Lammert and Elmar Brok, are calling for the creation of “corona bonds”, meaning that she is no longer isolated in her own party.

The pressure placed on Mrs. Merkel to find a political solution in Europe has not slowed since the stunning judgement handed down by the Federal Constitutional Court on May 5th. Until now, Berlin could count on the ECB to guarantee the liquidity of member states which, from the German point of view, made debates about a European financial policy less pressing. However, when the ECB is ordered to act with greater discernment, governments are compelled to act. In Germany, conservative journalists fear that from now on, permanent transfers within the euro zone will be the norm. [Note: Cf. Dorothea Siems, Die Kritiker der EZB sollten nicht zu früh jubeln, www.welt.de, 5.5.2020.]  

The same fear drives Mark Rutte’s government. The former, attempting to fill England’s Eurosceptic and economically radical place, also opposes “corona bonds” with the goal of preventing the creation of a European financial policy. This is, however, exactly what should have been done. For a long time now, the EU has not been a simple alliance of independent countries in which each one is responsible for its own economic situation. The Union has put in place common institutions, such as the single currency, which necessitates common responsibility. For the Secretary-General of the OECD, Ángel Gurría, “corona bonds” are the next step in accomplishing the European integration process.

It is clear that European bonds – or any risk sharing in general – will come at a cost to Germany. This cost, however, is insignificant compared to the even greater one that a second euro crisis would bring. Recently, the former president of the Dutch Central Bank, Nout Wellink, warned, “The North will lose its wealth if the South collapses.” He pointed out how much trading nations such as Germany and the Netherlands depend on a stable Europe.

Shared responsibility must therefore be open for discussion, for one thing is certain in these difficult times: neither technocratic compromise, nor impassioned appeals will save Europe. Only true solidarity can accomplish that.

Original article at Blätter here.