Alexander Hamilton must be rolling in his grave on hearing the happy talk that Europe is having its Hamiltonian moment. The truth of the matter is that the Eurozone is still lacking any semblance of a fiscal or banking union. That leaves Europe particularly ill-equipped to meet the existential threat that the COVID-19 pandemic is likely to pose to the Euro.
In 1790, Treasury Secretary Hamilton succeeded in engineering a permanent fiscal union for the 13 states of the new nation. He did so by having the federal government assume the debt of all the states, including those of the heavily indebted northern states. In exchange, the capital was to be moved to Washington, D.C., and the federal government was to be granted expanded tax authority. The resulting fiscal union was to serve the country well when it eventually became a full monetary union.
In 1999, when launching the Euro, the Eurozone countries chose to take a different route from the United States in that they decided to create a monetary union before they had established a political union. The past decade has indicated how costly a mistake that decision has proved to be. The Eurozone coped with the 2008-2009 Great Recession more poorly than the United States did, and it also experienced a growing economic divergence between its northern and southern member countries.
In response to the COVID-19 pandemic, the Eurozone has taken some very tentative steps towards a fiscal and banking union. After much kicking and screaming by the so-called frugal four countries—Austria, Denmark, the Netherlands, and Sweden—the European Union managed to establish a €750 billion recovery fund to aid the European countries hardest hit by the pandemic. This fund was to be financed by the issuance of a joint European bond and was supposed to be temporary in nature.
At the same time, the European Central Bank (ECB) expanded its quantitative easing program with the creation of a €600 billion Pandemic Emergency Purchase Program. The ECB also indicated that, in using those funds, it would no longer be bound by the ECB’s capital key. Instead, it would use its discretion to buy a larger proportion of bonds from those countries most seriously impacted by the pandemic.
A closer examination of these two European policy initiatives reveals how woefully inadequate they will be to meet the pandemic’s impending challenge to the Euro. This is particularly the case considering the collapse of the Italian and Spanish economies, the Eurozone’s third and fourth largest economies, both of which are now forecast to decline by more than 12 percent in 2020. That makes it all too likely that both of these countries may soon face both sovereign debt and banking sector crises.
Besides being temporary in nature and split roughly evenly between a grant and a loan component, the trouble with the Recovery Fund is its relatively small size and the fact that it is to be spread over the next three years. In relation to Europe’s economy, the fund is barely 2 percent of GDP per year. This might be compared to officially forecast 2020 Italian and Spanish budget of around 10 percent of GDP. The amount that Italy is expected to receive from the fund over the next three years would be less than 10 percent of its gross government financing needs.
Similarly, the ECB’s Pandemic Emergency Purchase Program would appear far too small for the task that lies ahead. Whereas the size of that program is €600 billion, Italy alone has a sovereign bond market of €2.5 trillion and a €4 trillion banking system. If Italy were to experience a sovereign debt and banking crisis, it is far from clear that the ECB currently has enough money on hand to bail Italy out. It would certainly not be able to do so if it had to bail Spain out at the same time.
Unfortunately, it is far from clear that Europe has the political will to act more boldly than it has to date. Europe’s frugal four northern member countries would almost certainly resist any notion of topping up the European Recovery Fund. Even if they conceded, the German Constitutional Court would very likely prohibit the Bundesbank from participating in an expanded ECB sovereign bond purchasing program, especially if the Court deemed such a program to be in violation of the Treaty of Lisbon’s unambiguous strictures against the monetary financing of a member country’s budget deficit.
All of this would suggest that Europe desperately needs a real Hamiltonian moment if the Euro is to survive the aftermath of the COVID-19 pandemic.