The French president Macron recently fired a warning shot across the bow of the European ship of state. He said that without making all EU countries mutually responsible for the debts of individual countries the EU could collapse. In March, Christine Lagarde asked eurozone finance ministers to consider a one-off joint debt issuance of “corona bonds” to assist with the coronavirus pandemic. But this has been met with opposition by Germany and other northern European countries, since they do not want to be responsible for the debts of the more spendthrift nations of the EU.
Before the crisis, Italy had a 135 percent debt-to-GDP ratio. Despite having more than a decade to reduce its debt after the crisis of 2008, Italy has consistently postponed dealing with the problem. Without pain or serious voter revolt, politicians will never take debt seriously and their countries will inevitably fail to reduce their debt. This is also true of the US, France, Japan, and even the UK. If a central bank can increase the supply of loanable funds at will, interest rates can be kept artificially low for a very long time. Even before this coronavirus crisis, the European Central Bank (ECB) was buying up massive amounts of “quality” debt in the form of sovereign and corporate bonds. This lowering of the yield curves across Europe also lowered borrowing costs for countries such as Italy. Without higher borrowing costs, there is no pain and thus no incentive to do anything about the debt. The actions of the ECB were essentially painkillers for spendthrift nations that do not deal with the underlying cancer of high debt levels. The ECB’s current policy of doing whatever it takes, including making massive purchases of Italian bonds, shows that it has no concern about preventing cancer from spreading, delaying the inevitable.
Why are Germany and others so worried about mutualizing their debt? Every euro the ECB prints is a tax on cash balances. It is a tax on every person in the eurozone. By monetizing Italian debt, the ECB is forcing every German citizen—every person using the euro—to pay for Italian profligate spending. The German government is obviously more concerned about its bondholders than its citizens; otherwise it would have vehemently opposed current ECB printing of bogus money.
Excessive debt is not just an Italian problem. France has a debt-to-GDP ratio of 98 percent but has already indicated that this will increase to 115 percent after promising Christmas presents in April. Of course, with the world economy slipping into recession, or possibly depression, a ratio of 150 percent is probably a more realistic number. This will be even worse for Spain and Italy. Without mutualizing debts, another Greece-like situation is a certainty.
Macron’s concerns are perfectly justified.
Like an obese person who sets weight goals, European countries quickly forgot the 60 percent debt to GDP target set in the Stability and Growth Pact. Europe was already a dead man walking. The corona crisis has simply exposed its underlying dysfunctional economic policies.
The clock is ticking on the existence of the EU. European nations will soon have the bleak choice of either ending the eurozone as it is now composed or being permanently stuck as a group in a low-growth, rising-inflation environment. A mutualization of debts means upward pressure on German interest rates.
If Germany and other northern European countries hold to their positions, a sovereign debt crisis will probably lead to the end of the euro and a return to national currencies. This scenario is by no means guaranteed, but if this happens it will obviously be a shock to the world economy. But not necessarily a disaster. We have many examples of countries switching currencies without disastrous consequences. The US went from the continental back to gold and silver. Germany went from the reichsmark to the rentenmark in 1923, and the French went from the assignat to the gold franc following the hyperinflation of 1790–97.
Would the end of the euro mean the end of the EU? It is hard to envision large, expensive EU institutions surviving the coming economic upheaval. Yet nothing stops countries from returning to the original costless intent of the EU—the free movement of people, goods, and capital between member nations. The end of the EU as a superstate, with its myriad of regulations, may not necessarily be a bad thing.
The COVID-19 pandemic itself will not be the cause of the cascade of economic events to come. The pandemic may short, but the economic ramifications of the lockdown policy will last far longer. Europe may be the first domino to fall, but others will surely follow. After all, Japan’s current debt-to-GDP ratio is over 200 percent and is set to become much larger.
Historians may look back on this period as illustrative of the folly of allowing central banks untrammeled power to manipulate the money supply and public finances. As the adage goes, “Absolute power corrupt absolutely.” This is true of central banks just as much as it is true of kings and parliaments.