Addressing members of the European Parliament on 27 May, Commission President Ursula von der Leyen proposed the creation of a ‘Next Generation’ European Union recovery fund worth €750 billion, to be raised by the Commission – a temporary Eurobond. The funds would be disbursed as €500bn in grants and €250bn in loans. The von der Leyen proposal followed the announcement of a deal between Germany and France on 18 May for a common debt instrument to raise €500bn to be disbursed as grants.

Her plan was welcomed by many EU government leaders and has been hailed by the media as “historic”, “fiscal shock and awe”, and the EU’s “Hamilton moment”. The latter refers to the agreement between Alexander Hamilton and Thomas Jefferson in the US in 1790 for the new federal government to assume the colonies’ wartime debt, viewed by historians as a defining moment in the development of the US federal system.

The Commission proposes to temporarily lift the ceiling on the EU’s own resources by 0.6 per cent of the EU’s gross national income in order to borrow the €750bn on the financial markets, to be spent during the period 2021-2024. The bonds will be repaid after 2027 and before 2058, and have varying maturities. If the Commission proposal is agreed upon by all 27 member states and the European Parliament, it will not be the first time a Eurobond has been used, but it will be the first time that a large sum is raised.

The recovery plan aims to boost certain aspects of the next long-term EU budget, the Multi-annual Financial Framework (MFF). The heart of the proposal is the creation of a new ‘Recovery and Resilience Facility’ of €560bn.

There are, of course, strings attached to the recovery facility, which will be “embedded” in the European Semester, the EU’s framework for surveilling and controlling member states’ national budgets. The funds raised will not go directly towards governments but will be administered through the MFF.

According to the plan, “Member States will design their own tailored national recovery plans, based on the investment and reform priorities identified as part of the European Semester”. A survey of the reforms pushed by the Commission through the European Semester process identifies increasing the pension age, cutting funding to health, restricting wage growth and reducing job security, and cutting welfare supports to be among the most common priorities.

Financial wizardry

In her Brussels speech, von der Leyen said the Next Generation fund would “sit on top of a revamped long-term EU budget of €1.1 trillion,” bringing the new measures she was announcing to €1.85tn, on top of the earlier package of €540bn. “In sum, this would bring our recovery effort to a total of €2.4 trillion.”

A breakdown of the numbers shows this is a serious distortion of reality.

The first response package that supposedly consisted of €540bn includes €100bn in loans for short-time work schemes and €240bn in potential loans from the European Stability Mechanism bailout fund (ESM) – that has so far been left untouched because it is politically toxic due to its association in the minds of the public with the hated Troika. The last component of the first response package consists of €200bn in European Investment Bank loans to SMEs – but the Commission is basing this figure on “leveraging” €25bn to mobilise private capital to make up the remainder. In reality this “€540bn package” consists of €100bn in loans that will actually be disbursed, and €25bn of additional funding for the EIB.

The European Parliament, usually on board with massaging the numbers through “leveraging” in order to impress their constituents, warned the Commission earlier this month “against the use of financial wizardry and dubious multipliers to advertise ambitious figures” in its response to the pandemic because the EU’s credibility was at stake.

The €1.1tn figure is the EU’s long-term budget so should not be included in examining the specific responses to the coronavirus pandemic and related lockdowns. In any case, this figure is even lower than the Commission’s 2018 legislative proposal for the budget that will run from 2021 to 2027. The EU’s budget consists almost entirely of contributions from member states based on their GNI.

The long-term budget has been steadily declining as a percentage of GNI-based contributions since 1995. The three institutions – the Parliament, Commission and Council of 27 member states – have been arguing fiercely over the size and content of the next MFF since 2018. The MFF operating from 2014-2020 was set at 1.03 per cent of EU28 GNI, but that rises to 1.16 per cent of EU27 GNI, once the British contribution is removed.

The Commission’s 2018 proposal for the 2021-2027 MFF was for 1.11 per cent of EU27 GNI, a sum of €1.135tn. The Parliament wants more, while a group of member states refuse to countenance contributions of more than one per cent of their GNI.

The current proposal before the Council, put forward earlier this year by its president Charles Michel, is for an MFF of 1.069 per cent of GNI. It includes a massive increase in expenditure on security and defence, with severe cuts to spending on cohesion and the Common Agricultural Policy, by -12 per cent and -14 per cent respectively in comparison to the current MFF.

Cuts of this magnitude would be devastating to many of the EU’s so-called peripheral economies, who are disadvantaged by the architecture of the monetary union. For example, 80 per cent of public investment in Portugal relies entirely on EU cohesion funds.

The von der Leyen proposal for a budget of €1.1tn is slightly higher than what is currently on the table at the Council but still represents a retreat from the Commission’s original proposal. Her plan includes using the funds borrowed by the Commission to reinforce certain budget programmes including adding €55bn to cohesion policies, around €32bn to the planned Just Transition Fund (originally proposed to receive a paltry €7.5bn), and €15bn to rural development. While directing some of the borrowed funds back into cohesion and rural development will help restore some of the resources these programmes were to lose in the next MFF, the final outcome actually represents a cut to the existing level of funding.

The centrepiece of the von der Leyen proposal – a new Recovery and Resilience Facility of €560bn – consists of grants of €310bn and loans of €250bn. Loans of any kind should not be included in assessing the response to the coronavirus pandemic; all member states can borrow at low interest rates.

If we remove all the spin, the amount of real new funds from the EU for this recovery plan is €310bn. It is not an insignificant sum, and it has been welcomed by countries such as Italy and Spain. But it is nowhere near the €2.4 trillion touted by von der Leyen in her speech.

Even the proposed €750bn in borrowing represents is in reality less than what was put forward in the German-French plan for €500bn in grants.

Crunching the numbers, Eurointelligence estimates that, “The recovery element of the package amounts to an annual 0.56% of the EU’s 2019 GDP, for four years”.

Long depression 

The economic outlook has grown darker each week for the past three months. The Commission estimates that EU GDP has already fallen by 15 per cent in the second quarter of 2020 compared with 2019. The optimistic estimate is that GDP will fall by more than seven per cent in 2020 – but the Commission notes that this will be around 10 per cent in the worst-affected countries.

However, if a second wave of infection leads to extended lockdown measures, EU GDP may drop by 16 per cent this year. It is increasingly unlikely that a second wave can be avoided, given that several countries that eased lockdown measures, such as China and Germany, quickly experienced an spike in the infection rate.

Eurozone member states have so far spent around four per cent of eurozone GDP, with around 20 per cent of eurozone GDP committee to loan guarantee schemes. But there is a huge difference between the member states’ responses, based on the sate of their public finances. German spending accounts for more than half of all state aid used so far, with its measures totally 29 per cent of German GDP. Italy, by comparison, has spent 17 per cent of its GDP.

The debt and deficit rules of the Stability and Growth Pact – that states’ debt-to-GDP ratio must be kept below 60 per cent, and annual budget deficits must be limited to three per cent of GDP – have been temporarily suspended but are enshrined in the Treaty and will return.

Under the Next Generation plan, the Commission’s €750bn debt will be repaid using three possible options, with von der Leyen saying her preference is for the EU to raise new own resources in future, such as a digital tax, a carbon border adjustment tax, the expansion of the emissions trading scheme, and a tax on large multinationals. The other two options are to pay back the money through future EU budgets until 2058, either through increased member state contributions or reduced programmes.

Raising significant new own resources will be difficult without changing the Treaty on the Functioning of the EU, which requires unanimous voting on taxation in the Council. A carbon border adjustment tax may gain the support of member states, but corporate tax proposals always stumble in the Council due to the opposition of a cabal of the EU’s tax haven member states – which includes the Netherlands, Luxembourg, Ireland, Belgium, Hungary, Malta and Cyprus.

Proposals for a financial transaction tax, a common consolidated corporate tax base, and a turnover tax on digital companies have been defeated or blocked in the Council. The proposal in the German-French plan for a minimum corporate tax rate in the EU was absent from von der Leyen’s proposal.

In its Financial Stability Review released on May 26, the European Central Bank (ECB) predicted public debt will reach 200 per cent of GDP in Greece, 160 per cent in Italy, 130 per cent in Portugal and 120 per cent in France and Spain. On average, Eurozone debt will rise from its current 86 per cent of GDP to above 100 per cent, while average deficits will be eight per cent of GDP.

Several states including Italy, Spain, France and Portugal will have to refinance large proportions of their debt within the next year. The ECB warned: “The associated increase in public debt levels could also trigger a reassessment of sovereign risk by market participants and reignite pressures on more vulnerable sovereigns.”

The Commission acknowledges, “Government finances may be permanently weakened”. This presents a unique problem in the Eurozone due to the ‘no bailout clause’ in the Treaty that prohibits direct monetary financing of government debt by the central bank, and the Stability and Growth Pact rules that impose a deflationary dynamic in a downturn.

The issuance of common bonds could be welcomed if the ECB was permitted to purchase unlimited bonds and cancel the debt or hold them in perpetuity. The Next Generation plan fails to deal with the fundamental contradictions of the EU’s economic architecture; it will add to member states’ national debt and trap them in a permanent austerity spiral.

Germany did an about-face on the question of eurobonds this month after its constitutional court ordered the country’s central bank, the Bundesbank to stop participating in the ECB’s quantitative easing programme within three months unless certain conditions are met.

The implication of the ruling is that the German court believes for the ECB to comply with the monetary financing prohibition, it can no longer take the “whatever it takes” approach of guaranteeing unlimited support for eurozone economies.

Far from being a “Hamilton moment”, this plan represents German acquiescence to doing the bare minimum to hold the Eurozone together in the short term.

Emma Clancy is the editor of Irish Broad Left. Follow her on Twitter @emmaclancy123.

This article originally appeared in Tribune on 29 May.

Top image is of Commission President Ursula von der Leyen addressing the European Parliament on 27 May. Photo: European Commission.

Explainer: What’s at stake at tonight’s Eurogroup meeting (starting at 5pm) to decide the EU/eurozone recovery package in response to the corona-economic crisis.

(Adapted from a Twitter thread @emmaclancy123)

The Eurogroup (eurozone finance ministers) met for 16 hours on Tuesday without reaching agreement. There are two main points of contention: the creation of a common debt instrument (coronabonds) and the use of the existing bailout fund, the European Stability Mechanism (ESM), which has €410 billion.

The ESM is a fund that makes loans, conditional on “structural reforms” and harsh austerity à la the Troika bailouts. Eurobonds have long been proposed as a solution to eurozone divergence but were shot down by Germany and others during the sovereign debt crisis.

The basic concept of the Eurobond is that an EU instrument would pool the issuing of government debt by the members of the common currency. All of the debt would be rated equally, and would not be on the member states’ books. This would lower borrowing costs for the so-called periphery but reduce the privilege of the core.

Despite the common currency, the bond market has treated the bonds (debt) issued by different eurozone states as very different. During a crisis, capital flees the risky states and flows to the “safe” bonds, namely German bunds.

If the sovereign bond market doubts the ability of high-debt states to repay their debts, the market will “price” the debt higher with a risk premium – applying much higher interest rates to these governments and even denying them access to the market.

This is what happened during the eurozone debt crisis, causing the bankruptcies & Troika bailouts. An important note here: states that have their own currency do not need to consider such a problem because their currency will be backed up by their own central bank, and they cannot go bankrupt.

On March 25, leaders of nine member states – France, Italy, Spain, Portugal, Ireland, Greece, Luxembourg, Slovenia and Belgium wrote to Council president Charles Michel calling for a “common debt instrument issued by a European institution to raise funds on the market” – i.e, coronabonds.

This position is supported by the ECB, which (correctly) has stated that the monetary and fiscal response to the crisis need to be combined and coordinated. The ECB has said a fiscal intervention of  €1.5 trillion will be needed in the EU in 2020 (likely an underestimation).

The Netherlands has strongly come out against coronabonds, backed by Germany, Austria and Finland, the so-called “Frugal Four”. The obnoxious Dutch position is making headlines but as always, the German position is key.

The best-case scenario for a coronabond is one issued by the European Investment Bank, unlimited and unconditional, guaranteed by the ECB. The ECB is the only institution with the power to back the spending necessary to deal with this crisis.

While the ECB is prohibited by the Treaty (Articles 123 and 125) from directly financing governments, it is permitted to make purchases from the EIB, a public bank.

But the benefits of a coronabond depend entirely on its design. It could be designed to allow governments to borrow at low costs and keep this debt off their balance sheets. Or it could be designed with the usual EU austerity conditions attached (and/or to be “securitised”).

The French compromise going into Tuesday’s Eurogroup meeting was for a new fund to “issue bonds with the joint and several guarantee of EU Member States”, to be operated by the Commission and guaranteed by a new resource such as a “solidarity tax”.

Germany and France have reportedly now agreed not to include this in the text. So, if media reports are correct, coronabonds are off the table and the debate is now only on the conditions to be attached to the use of the ESM (though France may lead the nine willing states in setting up a common bond between themselves).

Leaving aside the repugnant nature of the ESM in general, even from the EU leaders’ own criteria it is entirely unsuited to this situation. It was designed to provide conditional credit lines to member states facing an asymmetric shock, who can’t borrow in the markets.

The Commission’s ‘non-paper’ leaked before the Eurogroup meeting proposed two new ESM instruments, a Pandemic Crisis Support Enhanced Conditions Credit Line (ECCL) of up to 2% of a member state’s GDP and a Rapid Financing Instrument (a smaller fund of €80 billion).

Both ESM instruments have conditions attached, that they are only to be used for health & economic emergency spending, & states must adhere to the fiscal rules. See the proposal here.

The substantial credit line (ECCL) proposed conditions are ensuring “respect of EU fiscal rules and European Semester… with this commitment to be laid out in a “Memorandum of Understanding, which would be based on common terms for all Members”.

It’s similar wording for access to the rapid financing instrument. The generous gift of the northern states is to include a reference to “any flexibility applied by the competent EU institutions” to the EU fiscal rules (the Stability and Growth Pact rules have been temporarily suspended).

Remember, the SGP rules apply to annual deficits (to be kept below 3% of GDP) AND to accumulated debt (to be kept below 60% of GDP). When the rules apply again post-crisis, high-debt states will be in a permanent debtors’ prison, forced to implement the inevitable austerity the Commission will demand.

Reportedly, the key remaining sticking point is that Italy wants the reference to a Memorandum of Understanding to be removed and the Netherlands refuses.

The Dutch government also opposes including a reference to “innovative financial instruments”, a vague reference to the future possibility of coronabonds agreed on by most states.

At this stage it appears that France, Italy, Spain and the other signatories to the letter calling for coronabonds are prepared to give up on all of their demands in exchange for the removal of the term “memorandum of understanding”.

To summarise: The Eurogroup is right now in a vicious fight over a LOAN from the bailout fund that will add to government debt, increase borrowing costs on the market, need to be repaid, and inevitably have austerity conditions attached.

Bond markets appear relatively calm, assured by the ECB’s recent actions, though yields are spreading somewhat (the market is increasingly pricing Italian and Spanish debt as riskier).

The immediate fallout from this farce will be political. The southern states asked for solidarity in the midst of a horrific pandemic and had the door slammed in their faces by Germany, the Netherlands, Austria and Finland.

The longer term implications will be both economic and political. It is no exaggeration to say this week is a defining one for the future of the common currency and for the EU. What’s the point of the euro and the EU?

It is crystal clear that direct monetary financing of government spending by the ECB is the answer. All of these limitations are ideological and self-imposed.

Governments should refuse to use the ESM, borrow what they need on the market in the expectation that the ECB will purchase their bonds, and demand that the suspension of the Stability and Growth Pact is permanent.

Image above shows Dutch Minister of Finance, Wopke Hoekstra (left) talking to German Federal Minister of Finance Olaf Scholz. Getty Images.