Europe’s every-country-for-itself mentality is breaking down as the ugly truth sets in. If the coronavirus outbreak spreading across the continent takes down the weakest countries, the European Union and the euro zone – the most ambitious geopolitical and economic experiments since the Second World War – would cease to exist.
The question is whether the emerging communal effort is too little, too late. It might be unless something akin to a monetary and fiscal Marshall Plan is put into place and there is little sign of one galloping to the rescue.
Europe has become a COVID-19 battle zone. Italy, the European epicentre of the outbreak, was unable to box in the virus, which is now hitting Spain, France and Britain particularly hard and essentially shutting down their economies. By Friday, the European COVID-19 pandemic death toll was approaching 14,000 and climbing rapidly.
The initial response to the European outbreak was late and lame. Transportation links were slowly cut and borders went up. Quarantine efforts were half-hearted and some remain so, such as Britain’s. Italy asked for medical supplies and doctors from EU colleagues and got none. External help came from Russia and China, even Cuba. The sight of convoys of Russian military trucks on Italian roads would have been unimaginable in a NATO country only a few weeks ago.
The economic response at first was underwhelming, given the sudden mass closings of businesses and industries and the soaring unemployment rates.
The European Central Bank left interest rates unchanged but ramped up its quantitative easing (QE) program – the purchase of sovereign bonds and some corporate bonds. When ECB president Christine Lagarde later realized the sheer scale of the economic carnage, she cranked open the QE spigot, taking the purchase of financial assets to as much as €750-billion ($1.2-trillion) by the end of the year. She called on governments to use their fiscal firepower to protect jobs – an admission that ECB was running out of ammunition.
Some countries responded, notably Germany, which tore up its fiscal rule book and announced an unprecedented economic stimulus package that ends the government’s Ahab-like pursuit of balanced budgets. The package will be worth as much as 30 per cent of gross domestic product and include more than €500-billion of corporate debt guarantees through a state bank, €100-billion of equity injections into companies that are in danger of collapse, and €50-billion for small businesses and the self employed.
Germany can afford such a lavish rescue package. No other country in Europe can, certainly not Italy or Spain, the large economies that barely made it through the 2008 financial crisis alive and were struggling even before anyone heard of COVID-19. Italy could barely muster a spending package worth €25-billion as the virus smashed through its economy.
Italy is staring into the abyss. A new recession is certain and an outright depression – a GDP decline of 10 per cent or more – is certainly possible. The Italian financial advisory firm Prometeia last week forecast a 6.5-per-cent fall in full-year GDP; Goldman Sachs expects a decline of 11.6 per cent. The longer the severe lockdown lasts in Italy, the deeper the downturn and there is little sign that Italy’s COVID-19 crisis has peaked.
Italy, and the euro by extension, face a dangerous moment. Italy is the EU’s third-biggest economy and its economic destruction would bring down banks, industries and businesses across the continent. Imagine the Greek debt crisis times 10. While the ECB’s QE program, combined with the Italian government’s meagre spending program, will buy some time, it won’t buy much. Germany has taken care of itself. Italy can’t – it needs help.
An option for Italy is to tap into the euro zone’s standing, €500-billion bailout fund, the European Stability Mechanism. Prime Minister Giuseppe Conte made a plea for emergency ESM credit lines. But the ESM would want its money back, plus interest, and might demand loan conditions that Italy would find impossible or humiliating to meet. With a crushing debt load already – Italy’s debt to GDP ratio is 135 per cent – and a shrinking economy, Italy cannot afford to pay off more loans.
A second option is common bonds – eurobonds – that could be used to fight the crisis. The so-called coronabonds might be issued by the ESM. Backed by the entire euro zone, they would be highly secure and liquid, and come with bargain interest rates.
The idea of a common bond has been floated for years, but has never gained traction because of opposition from Germany, the Netherlands and other wealthy northern European countries. They consider common debt an unwarranted reward for the southern European countries who failed to get their acts together. The coronabonds idea went nowhere at an EU finance ministers meeting this week.
But the pandemic is rapidly changing the calculus of the EU and the euro zone, throwing its structures and prejudices into doubt. Foundering Italy could sink the whole region. Angela Merkel will soon have to make a crucial decision in her waning days as German Chancellor that could define her entire premiership: Will she allow an Italian rescue that would start with coronabonds or will she risk watching the European project disintegrate? Given economic wreckage, she might not have much time to decide.
Eric Reguly