The Corner

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The Eurozone’s Dutch Treat

A cyclist crosses an empty square in central Maastricht after Dutch schools, cafes, restaurants, and sport clubs were told to close down as the Netherlands imposed tight restrictions to prevent the spread of the coronavirus in Maastricht, Netherlands, March 16, 2020. (Francois Lenoir/Reuters)

With no progress (however that might be defined) so far on resolving the extent to which the Eurozone as a whole (as opposed to just the ECB, the European Central Bank) will step in to help out those of its member-states most battered by COVID-19, Germany appears to be hiding behind The Netherlands:

From the Irish Times (in a report highly unsympathetic to the Dutch view):

It took 16 hours of video conferencing for the finance ministers of the euro zone to find out that once again, they could not agree….

What’s (mainly) at issue is the Dutch are continuing to object to the idea of jointly-issued ‘Coronabonds’ backed by the Eurozone as a whole.

The Irish Times correspondent suggests that the Dutch will yield (I’d agree, one way or another), but:

The great fear is that by then it will be too late to turn back a tide of disgust in Italy towards the entire EU project.

The Italian economy has hardly grown since it joined the euro in 1999. You can take your pick of domestic problems to blame: onerous laws that people ignore, a musical-chairs succession of weak governments, an aging population.

But the fact is that the country has not seen the benefits of the euro. It has people old enough to vote who have known only economic stagnation.

The uncomfortable reality is that this was always going to be the case. Italy essentially cheated its way into the nascent currency union, with the assistance, critically, of German Chancellor Kohl.  Its domestic problems were real enough but the idea that the country could be scared straight by replacing the accommodating lira with a euro that it could not devalue was always nonsense (as, indeed, was the idea that the euro was going to do much good for most of its other members, but that’s a debate for another time).

Ashoka Mody writes in The Spectator (my emphasis added):

The ECB could keep buying the Italian government’s debt to prevent a default. But it is not the task of a central bank to deal with insolvencies. Moreover, such an effort would be technically and politically fraught for the ECB, which is not a normal central bank. The ECB is the central banker to a confederation of nations, each of which maintains fiscal sovereignty. If Italy is pushed to the brink, the ECB will struggle to help. The current ECB bond-buying limit of a trillion euros is designated to purchase the bonds of all member states. Italian government debt is over two trillion euros, which will increase further if the government is forced to financially prop up the country’s banks. If Italy is bailed out, other member states on the ECB’s Governing Council will face buying so much Italian debt that the ECB would own Italy. If then, the Italian government is unable to service its debt to the ECB, other member states will face the charged task of using their tax revenues to replenish the ECB’s capital.

Alternatively, leaving Italy to fend for herself could cause widespread Italian defaults, triggering defaults by those who have lent to the Italian government and banks. A cascade of defaults would go up the chain to European and global pension and insurance funds, inducing a global financial panic.

Germany appears to be content to shelter behind the Dutch for now, but (in another article largely unsympathetic to the Eurozone’s ‘frugal four’ — Germany, The Netherlands, Finland and Austria) Matthew Karnitschnig and Hans von der Burchard, writing in Politico, noted a poll from late-March in which 65 percent of Germans were opposed to a Coronabond issue, and:

There’s broad consensus from Vienna to Berlin to Helsinki that corona bonds are a no-go. The northerners worry (with some justification) that once the taboo is broken, eurobonds would be here to stay.

“With some justification” is an understatement.

So how about the ESM?

The measures currently under discussion in Brussels for the entire eurozone — a combination of credit lines from the European Stability Mechanism bailout fund, unemployment assistance and reduced-rate corporate loans — equal less than half of what Germany has prescribed for itself. The reason the deal on the table is so attractive to Berlin is simple: it costs Germany relatively little (if no one defaults). The ESM, for example, could rely on its existing lending capacity to extend whatever credit countries apply for.

But:

[T]he sums currently under discussion are unlikely to be anywhere near enough.

Italy alone will need financial assistance in the scale of €200-€250 billion to stay afloat, said Gabriel Felbermayr, president of the Kiel Institute for the World Economy. But the ESM loans under discussion in Brussels would only total €200 billion for all eurozone countries combined.

In order for the fund to lend more, German and the other euro members would likely have to increase the fund’s capital base, triggering another contentious debate in Berlin. But waiting to do so until Italy and Spain’s economic position deteriorates further is bound to increase the cost of rescuing them and could even make doing so impossible. In contrast to Greece, one of Europe’s smallest economies, Italy and Spain are the bloc’s third- and fourth-largest respectively.

Rock, meet hard place. My guess continues to be that the ‘frugal four’ will eventually cave, but will do everything they can to confine rescue efforts to the ESM. If that fails, their political class will finally have to choose between admitting to their voters the obvious and inconvenient truth that the euro has been a disaster — or, alternatively, let them down yet again.

Precedent suggests that they will choose the latter.

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