Macron issues ultimatum to Europe's German bloc: cough up Covid trillions or lose the single market
By Ambrose Evans-Pritchard, 24-4-2020
European leaders have dodged their "moment of truth". The Covid-19 emergency package averts an immediate crisis but fails to draw the political poison now threatening monetary union.
It has not cut Italy’s borrowing costs to bearable levels and is too little either to ensure the economic viability of southern Europe’s debt bloc or prevent the North-South divergence from spiraling out of control.
It leaves the European Central Bank holding the fort, compelled to cover to the exploding debt issuance of eurozone treasuries and to work overtime to stave off a run on Club Med bond markets. This places the institution in an invidious legal position.
The vague agreement on Thursday night was billed as a compromise. EU veterans say that it was in reality a "German" outcome, repeating the pattern of the eurozone debt crisis.
The northern bloc rejected any serious move towards joint debt issuance or fiscal transfers. Aid will come in the form of loans and must be repaid. Any extra debt will be subject to the surveillance and contractionary ideology of the EU Fiscal Compact once the pandemic is over.
Chancellor Angela Merkel said grants of money are "not in the category of what I can agree". She warned peers with icy precision that if Europe is going to spend vast sums then all states would have to submit to “coherent taxation policies”.
This is a polite way of telling Italy that the quid pro quo is wealth confiscation to restore debt solvency, akin to what happened in the early 1990s or with Argentina’s corralon. It sends shivers down Italian spines.
The new Recovery Fund – to be fleshed out next month by Commission technocrats – will be linked to the EU’s internal budget and mostly come in the form of lending. It will be subject to Treaty Article 122 to keep tight control. Two-thirds of the trillion-plus headline will be achieved by "crowding in" private money. Eurointelligence says the intent is to "impress the gullible".
French president Emmanuel Macron did not pretend that there was a summit breakthrough. In a remarkable outburst afterwards he issued what could be interpreted an ultimatum.
He had a warning for those rich northern states that "profit" so handsomely from exporting to the South: they might wake up one day to find that the EU single market is "no longer there" unless they are careful. "If you let part of Europe fall, the whole of Europe will fall," he said.
"The countries that are blocking are the same ones as ever, the frugals: Germany, the Netherlands... whose deep psychology and political constraints justify very hard positions," he said.
This accusatorial tone will surely grate in Berlin, the Hague, or Vienna. They know that Mr Macron is trying to bounce the North into fiscal union, exploiting the emotions of the pandemic to change Europe’s constitutional structure. Such a jump violates treaty law. It breaches the German Basic Law and alienates the Bundestag’s tax-and-spend prerogatives. It cannot legally be done with a flick of the political fingers.
Nor is France an honest broker. Marchel Alexandrovich from Jefferies estimates that a U-shaped recession will push France’s public debt to 135pc of GDP this year. It would hit 142pc under a W-shaped slump caused by rolling lockdowns and delayed recovery.
France and Germany had similar debt ratios before the Lehman crisis in 2008. They have since diverged dramatically. The pandemic shock – symmetric in origin, asymmetric in its effects – is turning France into a full member of the vulnerable Latin bloc.
But Mr Macron is also right. Loans pile more debt on countries already drowning in debt. "That won’t resolve the underlying issue," he said.
Covid-19 requires a vast Marshall Plan financed by "joint debt" and "budgetary transfers" to the hardest hit regions. "Our Europe has no future if we don’t do this," he said.
Markets have reacted calmly so far. Italian risk spreads remain stretched – and unsustainable – at 240 basis points but they have not widened.
The EU did agree on other measures with a nominal value of €540bn but this figure is financial legerdemain. One component is really just €25bn of actual money from the European Investment Bank, to be levered up by private funds to €200bn. "Previous experiences with similar structures such as the 2016 Juncker Plan have been mixed, to put it mildly," said Holger Schmieding from Berenberg Bank.
There is €100bn in loans for Kurzarbeit jobs support. The last €240bn is to come as lending from the EU bail-out fund (ESM) on "light conditionality". This is politically toxic in Italy – deemed a Trojan Horse for a Brussels take-over - and it is unclear whether any country will touch it.
Citigroup said each country is being left to meet the shock on its own and therefore that the package will fail to convince markets. "That leaves the ECB, yet again, as the first and last safety net for Europe," it said.
The ECB’s Christine Lagarde told EU leaders that doing "too little, too late" risks repeating past errors and is courting fate. She warned that the eurozone could contract by 15pc this year.
Mrs Lagarde also pointed out the fundamental injustice and economic dangers of what is happening. The strong states are spending up to 14pc of GDP directly to keep their economies whole and ensure a rapid rebound: the weak dare not match this. Some are spending as little as 1pc, implying lasting damage and a blighted recovery.
Jefferies estimates that a W-shaped scenario would push debt ratios to 183pc of GDP in Italy and 158pc in Portugal. "Markets are also starting to see just how damaging this recession will be to public sector finances," it said.
Worse yet, the weak may be left further behind in the early 2020s. Giada Giani from Citigroup says Italy will not fully recoup this year’s lost GDP in 2021, and will then flat-line in stagnation until the middle of the decade.
This will destroy monetary union if allowed to occur. The ECB will avert an immediate crisis by mopping up Italian debt under its "pandemic QE" plan. But it cannot keep doing this forever.
Italian debt made up one third of the ECB’s total bond purchases in March, double the country’s "capital key", yet this has failed to hold down Italian yields. Private sellers are off-loading their bonds on the ECB and rotating the proceeds out of the country in what amounts to capital flight.
These flows will surface in the ECB’s Target2 payments data. The Bundesbank is in effect having to provide a forced "credit" to Club Med central banks that will soon blow through €1tn. At some point this will become politically and legally untenable.
The German constitutional court will rule on May 5 on how far the Bundesbank can go in supporting the ECB’s emergency policies. The exact wording will be crucial. Markets may suddenly discover that the ECB cannot play the role of permanent saviour after all. Then what?
