The emergence of the European Recovery Plan, taking final form during marathon negotiations in Brussels (July 18–21), has run in parallel with the euro and Italian government bonds, joining a wider asset market frenzy in the midst of a still depressed global economy. Income famine investors, desperate for yield in a world of monetary repression, are chasing yet another dubious narrative, this time about Europe, even though key storytellers have an obvious interest in captivating a wide audience.
As case in point, a leading US investment bank whose alumni include powerful officials in European central banks and finance ministries, itself steeped in a history of gaining big fees from the process of European monetary union over the past quarter century, is telling us that the “giant stimulus,” backstopped in some degree by Germany and Netherlands, promises a “new dawn” for the EU and the euro. Correspondingly, market commentators describe a stampede of global funds (Italian retail investors strikingly absent) into Italian government bonds (ten-year yields now down to 1 percent from 2.4 percent in mid-March) and into the euro (above $1.17/euro in late July compared to an eve of pandemic baseline of $1.10).
If there is a new dawn, it is for the Sinicization of Europe—China-style stimulus administered alongside a severely ailing financial system kept whole by widespread financial and monetary repression. Stimulus here means the government and the banks getting behind an array of vast state-selected investment projects to be pursued by favoured public enterprises. The adjudicators in Europe will be a new subcommission in Brussels, with very little accountability, it seems, despite Dutch best efforts. The good news (bad for the speculators in Tokyo and beyond) is that the Dutch resistance might yet succeed in sabotaging the EU train before it journeys much further in that direction.
Back to the narrative: the EU has now got its act together, putting into effect over seven years (2021–27) a cumulative spending (stimulus) program amounting to €750 billion, around 5.5 percent of one year’s (EU) GDP, of which a third is to be on green projects. Germany and Holland, the biggest net contributors to the EU budget, have retreated from their traditional reservations concerning “debt mutualization.” These two countries will gradually transfer funds into the EU budget over the rest of this decade to match much of the aid component (€390 billion) in the recovery plan. The financing of the overall “stimulus” (including the disbursement of concessionary loans amounting to €360 billion for favoured projects), is to occur via the issue of special EU bonds backed jointly by all member countries, which should prove to be a highly attractive investment for global money managers. The backstop of German and Dutch support, coupled with the ECB’s continuing massive “pandemic program” of bond purchases (QE) and lending directly to banks (LTROs [long-term refinancing operations]), dispels the spectre of an ultimate solvency crisis whether for the weakest banks or sovereigns.
In sum, according to the storytellers, the eurocrat dream of the euro winning big custom from the dollar is about to become reality. They tell us that these EU bonds will meet a great reception from global investors seeking a safe liquid alternative to prime dollar paper, until now in “scarce supply” (odd when the total stock of French government bonds alone is over €2.8 trillion, with similar credit rating and yield negativity). Incidentally, the leading US investment bank and its fellow traveling institutions in Europe, all cheering the EU plan, would be front of the queue for commissions on this €750 billion of EU bond issuance.
Even so, counting the chickens before they hatch might be the appropriate proverb here given how a global debt crisis with its epicentre in Europe could emerge before this recession or indeed depression is over. Global investors may yet open their eyes and view the postpandemic landscape through a lens other than that supplied by these tellers of the European recovery plan narrative.
The winning economies in the era beyond this pandemic will be those where the process of creative destruction driven by free market forces generates investment opportunity and its exploitation on a scale such as to bring a revolution of prosperity. The recovery plan which the EU heads have now drawn up runs in the opposite direction, of Chinese-style “stimulus.” The storytellers say that the high green content will win Europe a key lead position in the renewable fuel and environmental protection industries—on the same logic, it seems, that drove elements of the Obama megastimulus programs of 2009–10.
There are already grounds for scepticism given the intense intra-EU negotiations about implementing the top-down guideline that the funds should be disbursed disproportionately in countries and regions which suffered most from the pandemic—a process which has resulted in Poland getting the biggest quota relative to the size of its economy. Italy is on track to get around 20–25 percent of the total disbursement (equivalent cumulatively to around 10 percent of one year’s GDP), the aid component during 2021–23 and the concessionary loan component further ahead. There is some promise of an emphasis on health sector renewal—a challenge amidst evidence of mafia penetration into hospitals for money laundering operations.
These fund disbursements in themselves will not enhance the credit quality of Italian government bonds in any fundamental sense unless by some miracle they transform the Italian economy for the better. (Yes, disbursement of aid and loans can be halted for a review to take place if one member country objects that the recipient is not respecting EU guidelines on its budgetary policy, but this is hardly a serious restraint). Italian government debt as a share of GDP is set to rise to 155 percent next year from 135 percent on the eve of the pandemic, irrespective of the EU economic recovery plan. For now, Italian bonds are the global craze—the modern equivalent, perhaps, of the huge speculation purchases of reichsmark notes in the early 1920s—but there is a spectre haunting the party. Those savers in northern Europe, especially Holland and Germany, already weighed down by the monetary repression tax (symptomized by negative rates) levied to support the great solidarity programs of the European Central Bank, will they remain quiescent, especially once the stream of capital gains on high-risk bets turns to losses?
The Dutch resistance to the EU deal and its winning of a substantial reduction in the aid component clash with the view that the road to European solidarity is now clear. In fact it could well be that German chancellor Merkel was puppet master of the Dutch resistance in some respects, using it to push hard for aid reductions, which her own party (CDU/CSU [Christian Democratic Union of Germany/Christian Social Union in Bavaria]) would be only to glad to go along with given the strong antagonism to bankrolling EU largesse also amongst the German electorate. General elections are due within roughly a year in both Germany and Holland.
Those cheering the euro frenzy on the basis that the Dutch resistance has been broken, leaving no more serious obstacles to monetary union becoming a full fiscal union, are almost certainly wrong. There is nothing in the recovery plan which causes Holland or Germany to step in and guarantee other EU member countries’ debts (beyond the funding of the plan itself). The chief area of EU solidarity in government funding in any case is now the ECB expanding its giant balance sheet to fund lending to weak banks and weak sovereigns.
Even here solidarity is not guaranteed as permanent and can be revoked. Germany or Holland and indeed Austria or Luxembourg can yet walk away with retrospective effect from the solidarity operations of the ECB. Any one of these member countries can exit European monetary union and convert only its own residents’ holdings of deposits and government bonds into a reincarnated national money, leaving nonresidents to bear the brunt of loss on claims against a rump euro central banking institution. Whatever the narrative, financial and monetary repression administered by the euro elites is not as strong a preserver of the status quo as is the case for the China communist command.