Last Thursday, the Finance Ministers of the European Union agreed on an unprecedented spending package of €500B. They billed this move as a “stimulus” spending program.
However, some are saying it’s more accurate to call it a market “rescue” package.
The idea is for EU governments to significantly increase spending to offset the economic impact of the coronavirus. And this agreement was part of the discussion on how the EU was going to finance the extraordinary spending that would be necessary due to COVID-19.
Even though there was some agreement on Thursday, it still doesn’t mean that the debate over two competing mechanisms of obtaining financing (debt) is anywhere near over.
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North and South, Again
As usual, the debate splits along the countries in the “north”, led by Germany, and the “south”, led by France. The north is in favor of measures that imply more financial order, while the south is advocating for a more liberal financial policy.
They have two competing programs.
The first, the German favorite, is to dust-off the European Stabilization Mechanism. This was originally designed in the aftermath of the Greek debt crisis. The Austrian FinMin summarized the northern position as, the ESM already exists and it hasn’t been used yet. Let’s use it first, and then see if another form of financing is necessary.
The Coronabonds
The competing position argues in favor of joint debt issuance from all the countries in the eurozone, in “solidarity” as they’re promoting it.
The idea is that the EU would create a one-time bond that would be backed by all the countries in the Union equally. It would also help promote financial unification since all the participating countries would benefit and be responsible for the issuance.
Why this is preferable to the “southern” countries is that by being issued all together, they’d have the same interest rate regardless of the country of issue.
This means that countries like Spain and Italy, which currently have to pay higher interest rates, presumably would be able to access low-cost debt.
Why the Germans Aren’t Happy
Basically, the risk of EU countries would be spread around. This means more responsible countries like Germany would have to pay higher interest rates than they currently do.
But that isn’t the big problem. By being issued in “solidarity” then if a country can’t pay their coronabonds (say, for example, Greece), then the other countries of the Union would have to pay for them.
The “northern” FinMins are just too polite to come out and say they don’t want to participate in getting a haircut.
The current situation would mean an unprecedented increase in debt from especially among more financially vulnerable countries. Therefore, this increases the risk of default dramatically.
Resolution
The agreement on Thursday is yet to be ratified. So far, it would see Europe tapping the ESM for €240 billion. It’s also going to “delay” the discussion about coronabonds.
Many analysts see the latest package as a good first step, but insufficient in the medium term.
A second round of financing will undoubtedly come up for discussion. In that case another, we can expect a much stronger push for coronabonds.
