A 40-year implication of the historic €750 billion European fiscal agreement
Shall we go long on Europe and it’s Union?
The night of Monday, July 20 will be historic for the Europeans aand combined Europe dreamers for many reasons. Many European leaders came close to seeing the tax deal as hanging by a thread, the Financial Times reported. It was when Finland’s prime minister, Sanna Marin, rebuked Spain’s, Pedro Sánchez: “We’ve gone from zero to 350 billion in subsidies; what have you done?” Before dawn, however, the President of the European Council, Charles Michel, announced the agreement with a cry of “Deal!”
Europe is the result of an enormous weight of tradition. And the tradition was not lacking at the recent EU summit, where the agreement was reached, of course, at half-past five in the morning on the fourth negotiating day. Nevertheless, if in past meetings aspects of great importance for the construction of Europe have been negotiated, in my opinion, the consequences of the agreements reached last Tuesday are particularly significant.
Let’s see in figures how does it look like:
First, it is a question of a coordinated and robust fiscal response. In the past, if the monetary response had to be coordinated, the fiscal policy stood out because of its asymmetry. On this occasion, it seemed that the asymmetry was going to last, as a result of the enormous fiscal packages deployed by countries who saved during the ‘good’ years like Germany. As opposed to the much tighter fiscal stimuli of countries, like Spain, that did not know or did not want to balance the public accounts during the boom years to be prepared for adverse scenarios. This fiscal response, therefore, makes it possible to limit asymmetry, something that will be very beneficial for Europe’s future.
Second, the European Commission has been authorised to launch a huge bond issue (€750 billion, $858 billion, 5% of GDP) to finance a significant part of the reconstruction fund. Although the Commission issued bonds in the 1970s during the oil crisis, and also during the financial crisis, it was a much more modest exercise than the current one. The consequences of this decision are very relevant.
- Firstly, the bonds will set a European yield curve until 2058. An essential element to deepen the banking union and capital market union, establishing a risk-free European curve on which credit prices can be based.
- Secondly, the bonds will most likely have a maximum rating of AAA, allowing banks in many countries (other than the ECB) to purchase them, and not depend only on the purchase of government bonds from their country. An incestuous trend that fragments the monetary union and generates a contagion effect between banks and sovereigns, and vice versa.
Ideally, these instruments will allow the creation of ‘European guarantees’ in the future, which could be used to mobilise bank credit in the face of future crises. Today, guarantees are national, which exacerbates monetary fragmentation.
Third, for the first time, a significant volume of fiscal stimulus is being channelled in the form of a subsidy, not a loan. Indeed, lending to a country on a very long term basis at extremely low-interest rates (as was done with Greece) masks part of the subsidy. Still, a fiscal transfer of this magnitude has not been addressed to date. In my opinion, the fact that the fractures generated by COVID-19 were an exogenous shock and not the product of bad policies (like Greece until 2010) explains the answer.
Moreover, the austerity prescription imposed by the European Union after the bailouts of the last financial crisis led to a sharp increase in anti-Europeanism, spurred on by populists. The trend today is different: first, let’s fight the economic tsunami, and later let’s put the house in order (for which there are precise coercive mechanisms).
Fourth, much aid is linked to mutual control mechanisms to ensure that countries pursue medium-term economic and fiscal policies that help maximise growth and ensure fiscal sustainability (in layman terms, ‘balancing income and expenditure’). This is to avoid the attempt by many politicians to ‘buy votes’ by prioritising the present over the future, which ends up hurting the next generations (who have to pay the associated debt and for their impact on the economy) and the partners who helped in a time of difficulty.
Fifth, taxes are created at the European level. Although very low (40,000 million euros per year, 0.25% of GDP), it is an essential step in the fiscal autonomy of the Union.
Sixth, it takes the pressure off the European Central Bank, which in practice acted as a giant Atlas on which rested all the effort necessary to sustain the financing of the Member States and, therefore, the monetary union. This ultra-dependence on the ECB could be very dangerous, especially if it is interpreted that it was overstepping its mandate. But if the ECB did not act, who was left on the other side? Until last week, no one.
These historical changes can only be explained by the shift in opinion of Europe’s largest economy, Germany, which has so far been opposed to many of these measures. It may well be that the German Constitutional Court’s surprising ruling on the legality of ECB purchases executed through the Bundesbank opened the eyes of the German Chancellor to the extent to which the monetary union was hanging by a thread (perhaps also not running for re-election, frees her to defend necessary policies more freely). So far, it seems that the questionable German ruling has been dealt with well, which, paradoxically, has allowed a giant step forward in European integration.
I have spoken to international investors many times about the euro. They see it as a monetary and economic project, which is true, but sometimes they forget the political dimension. The founders of the European project already saw a common currency, and they did so with a pilgrim’s argument: it is very difficult for countries that share the same currency to end up fighting each other. There are examples in history, but very few, and even fewer if they are democracies with established middle classes (I do not know of any such war).
So perhaps we can understand the prophetic words of a former President of the European Commission, Romano Prodi, who said after the ‘crisis’ of 2001 (in perspective, that crisis seems to be a lie): “I am sure that the euro will force us to introduce a new package of economic policy instruments. It is politically impossible to propose it now. But one day there will be a crisis and new instruments will be created.”
We are there.
