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Back to the Future: The Return of the Euro-zone Crisis?

New 50 Euro banknote during a presentation by the German Central Bank in Frankfurt in 2017. REUTERS/ (Kai Pfaffenbach/Reuters)
Designed to be “irreversible,” the single currency combines the qualities of vampire, cockroach, and remarkably effective blackmailer.

In 2011, amid controversy over the euro zone’s bailouts for Greece and other casualties, Germany’s head of state, President Christian Wulff, did what German politicians — and, even more so, a German president — are not meant to do. He said the unsayable:

Solidarity is the core of the European Idea, but it is a misunderstanding to measure solidarity in terms of willingness to act as guarantor or to incur shared debts. With whom would you be willing to take out a joint loan, or stand as guarantor? For your own children? Hopefully yes. For more distant relations it gets a bit more difficult . . .

The unsayable is even more unsayable when it is true. Brussels may look down on the nation-state as dangerous anachronism, but it is, however imperfectly, a family in a way that the EU is not. The European “family” did not exist in 2011, and it does not exist in 2020. None of this is to deny that there is a certain degree of fellow-feeling among the EU’s “citizens,” but for most of them, it only goes so far, which was Wulff’s point. To Bavarians, Saxons are family in a way that Greeks are not.

This simple, unsayable fact is at the root of the dysfunction that was baked into the euro from the very beginning. The single currency was wildly premature on any number of grounds, but to launch the euro without some elements of a fiscal union to underpin it added recklessness to arrogance. Those, at least in Brussels, in charge of the project would doubtless have preferred just such an addition both politically and economically, but there was not enough national support for that, not least in Germany, the country that was key to the credibility of the new currency. There were plenty of good reasons for that resistance (the mistake was to proceed regardless), but one of the most significant was the unwillingness of some countries to pool, even if only partially (and/or contingently), financial risk with fellow member-states they did not trust to run their own affairs responsibly. Being on the hook for feckless Uncle Georg would be hard enough to swallow, but second cousin (once removed) Giorgio, well, no.

When, as it was always going to, the euro-zone crisis finally erupted, the same issues arose, but the pre-existing distrust was reinforced by the cavalier manner in which the early rescue effort was arranged. As the Wall Street Journal reported at the time, the then–French finance minister, Christine Lagarde, was quoted as saying this:

We violated all the rules because we wanted to close ranks and really rescue the euro zone . . . The Treaty of Lisbon was very straight-forward. No bailout.

Lagarde went on to run the IMF, weathered a conviction for criminal negligence, and is now the president of the European Central Bank.

The euro zone’s rescue systems were soon put on a sounder legal footing, but the lack of trust that had characterized the debate over the single currency’s establishment resurfaced during the discussions over bailouts intended to preserve it. The more financially disciplined states, generally in the euro zone’s north, felt that, despite repeated assurances that this could never happen, they were now being compelled to bail out the improvident. They were right. Meanwhile the countries in receipt of assistance believed that it was being delivered on terms that did not reflect the economic reality of what they were facing. And for the most part they were right too.

These divisions have not gone away. Indeed, the bailouts strengthened suspicions in the north concerning any sort of fiscal union (except under terms that the “south” would find unpalatable), suspicions that extend to the issue of “eurobonds” (in this sense), bonds that would be guaranteed by the euro zone’s members as a whole, and thus carry a lower rate of interest than government debt issued, say, by Italy alone. Even with some of the safeguards that have, on various occasions, been proposed should be built into such bonds, Germany and its allies have continued to reject them, fearing that, safeguards or no safeguards, they would end up being required to chip in. Precedent would suggest that their concerns are justified:

We violated all the rules.

And then along comes COVID-19, which (as I write) has hit Italy hardest of all the euro-zone countries. Human tragedy is being amplified still further by economic distress: The country has never recovered from its decision to join a currency union for which it was fundamentally ill-suited. Burdened by unimpressive productivity and high government indebtedness, it could no longer devalue its way out of difficulty with the lira gone. Italy was thus in trouble even before the devastation inflicted during the euro-zone crisis, devastation that has yet to be fully repaired. Expressed in constant terms, its GDP per capita was (before COVID-19) roughly at 2009 levels, and some distance below where it stood in 2002. Anyone trying to understand the rise of Italian populism (and growing euroskepticism) in this century can start there. It’s true that by last year, banks were superficially in better shape than a decade ago (low bar), but their holdings of Italian government debt have actually risen again, reviving concerns of a ‘doom loop” (or, to put it less politely but less melodramatically, that the Italian state and the country’s banking system are two drunks propping each other up). Italy’s debt/GDP ratio is now around 135 percent; Germany’s is approximately 60 percent.

COVID-19 (and the measures to combat it) have shut down large swaths of the Italian economy, and, like an immuno-suppressed patient, it is in no state to resist. Just under a week ago, the Italian economy minister was expecting the country’s GDP would fall by 6 percent, but a banking or debt crisis would make that forecast look optimistic.

Italy is not Greece. Greece was small enough to be bailed out, but the decision to do so was bolstered by fears that the wider economic and political cost of a Greek departure from the euro zone would be too great to bear. As the euro zone is managed today, however, Italy, the third largest EU economy, is both too big to fail and too big to bail out.

This would be a conundrum at the best of times, and, for the EU, these are not the best of times. Although the political cost/benefit analysis of Brexit to the EU is not straightforward, “ever closer union” has now been definitively been rejected by a major European state. What’s more, while its relationship with euroskepticism is more complicated than is often portrayed, the rise in populism within the EU is hard to square with how the union is currently run. And it is not going away any time soon. Nor will the boost that populism derives from discontent over mass immigration, which may well be sharpened yet again if COVID-19 wreaks havoc in the Middle East and Africa. As it is, the coronavirus has, at least temporarily, brought border controls back between countries from which they were supposed to have been largely consigned to the past. And then, of course, there are the tensions between the EU’s governing elite and the Polish and Hungarian governments . . .

Predicting the demise of the euro is unwise. Designed to be “irreversible, the single currency combines the qualities of vampire, cockroach, and remarkably effective blackmailer. Fear of the economic chaos that could follow its unraveling remains an even better guarantee of its survival than any ideologically driven insistence that “ever closer union” means what it says.

The most feasible way out of this mess — and it’s no magic bullet — would, as it has been for years, be either Germany’s exit from the euro or the division of the euro into “northern” and “southern” units. But those options apparently remain off the table. If that continues to be the case, all that’s left is a disorderly break-up (which would be very disorderly indeed), an Italian exit (which, whether forced or unilateral, would mean a cascade of debt defaults across Italy and beyond), or an agreement on some sort of joint funding mechanism for Italy arranged through the euro zone.

The European Central Bank has massively increased quantitative easing, announcing the purchase of up to €750bn in private- and public-sector debt, but even with other moves being taken at the national level, this is unlikely to be sufficient to dig Italy and others out of the even deeper hole into which COVID-19 has pushed them.

So far, the leadership of the euro zone’s “frugal four” — Austria, Germany, the Netherlands, and Finland — still opposes the issue of any joint debt instrument by the euro zone, even a (supposedly) one-off “Coronabond” designed to help countries most badly battered by COVID-19, partly out of anxiety that they will end up picking up much of the tab. And it would also be foolish to discount their fear that agreeing to such a bond issue would represent a significant slide down the slippery slope to a fiscal union that would, in the end (even if only as a matter of fact rather than law), act as a “transfer union,” under which the north would be transferring taxpayer funds to the south — in perpetuity.

So, what’s the next step? Both Angela Merkel and Dutch prime minister Mark Rutte have suggested that they would be open to channeling funding through the ESM (the European Stability Mechanism), the euro zone’s permanent bailout mechanism, but the strict conditions that could come with that — conditions that could (again, as precedent has shown) choke off or delay any real recovery in the borrowers’ economy — do not make it the most appetizing option for Italy, say, or Greece. But there are signs that the frugal four may be preparing to blink and accept that the ESM could be used to disperse the money with only limited conditionality. On Monday, Merkel, a politician not known for her original thinking, took refuge in the comfort of a familiar refrain:

The answer can only be: More Europe, a stronger Europe and a well-functioning Europe.

Translation: She has learnt nothing.

Translation: Concessions on the way.

However, throwing the ESM at the problem will not, I suspect, be enough to see the economies of Italy and other euro-zone members most badly hit by the coronavirus safely out of the ruin that COVID-19 will leave behind. Eventually (and only after a lot of shouting) some form of Eurobond — Coronabond, call it what you will — seems inevitable. The ratchet of integration will turn another notch.

The notion of a “beneficial crisis” is a well-used and effective part of the Brussels toolkit. Speaking in 2010, José Manuel Barroso, then the EU’s top bureaucrat, had this to say:

Once again, we can see that a crisis can accelerate decision-making when it crystallizes political will. Solutions that seemed out of reach only a few years or even months ago are now possible.

In this case, the ‘beneficial’ virus will probably be helping out too.

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