Italian insolvency can crash the euro currency

The ECB is paving the way for the euro zone towards a transfer union

Contrary to some claims, there is great financial solidarity in the euro zone, primarily through the ECB. Last but not least, Italy will benefit from this. But solidarity cannot be a one-way street.

If the European Union (EU) wants to be a real community, this must now be the hour of solidarity in the euro zone, in the EU and in Europe as a whole. Who could fail to see this, given the pictures of desperately fighting doctors in overcrowded hospitals in parts of Italy, Spain and France. In the meantime, medical assistance has picked up speed after it started soberingly, even disappointingly slowly, at the beginning of the crisis. First aid planes from China and Russia had to land in Milan, with media coverage, before one woke up in Europe's capitals. However, the discussion now revolves heavily around financial aid, especially for Italy and Spain. European support is probably inevitable, because two of the most indebted countries in Europe are now most severely affected by the coronavirus. If Italy wants to help its corporate sector as much as Germany does, many Italian companies could end up being saved, but the state could be insolvent. This is what happened to Ireland with the bank bailout in the financial crisis. The motto of providing assistance must therefore not be “need knows no command”.

Mixing of fiscal and monetary policy

In Italy, people are currently complaining particularly loudly about the alleged lack of help from European friends. What was correct for the slow start of medical support after the spread of the coronavirus in Lombardy, Italy's economic powerhouse, does not apply to financial aid. Probably no other euro member, with the exception of Greece, has received as much help as the Bel Paese in the past ten years. The support came mainly from the European Central Bank (ECB) - with the approval of political operations in the capitals of Europe. That is still true today. The ECB also pushed forward during the pandemic crisis. In a midnight decision in mid-March, the central bank's executives decided to launch a pandemic emergency bond purchase program (PEPP) worth a whopping 750 billion euros by the end of the year - and disregard almost all previously applicable restrictions. Should the ECB buy corporate debt with PEPP to ensure liquidity in this market, this would still be justified. But it will presumably use the lion's share to buy government bonds from countries like Italy in order to keep their refinancing costs in check. In doing so, it not only further mixes the boundaries between fiscal and monetary policy, but ultimately operates the monetary state financing that is prohibited in the euro zone and which has historically led to major economic upheavals.

Of course, the ECB once again received applause from many quarters for the emergency aid, but there were also other voices. Some economists rightly criticized that the pandemic program was not about monetary policy in the traditional sense and that the alleged disruption of the monetary policy transmission mechanism was once again a pretext. The allegedly disrupted transmission of Frankfurt's monetary policy to the regions of Europe has served the ECB for years as a welcome excuse to justify all possible interventions. The pandemic program is a crisis instrument and is reminiscent of the Securities Markets Program (SMP), with which the ECB under the then President Jean-Claude Trichet bought mainly Italian, Spanish and Greek government bonds from 2010. The program was replaced in 2012 by the OMT program from Trichet's successor, Mario Draghi. However, the Governing Council does not have a democratic mandate to help individual countries; it is solely committed to price stability in the euro area. Country-specific aid is the task of politics.

Artificially low interest rates

The OMT program - the acronym stands for Outright Monetary Transactions - was introduced during the sovereign debt crisis under certain conditions for the targeted and potentially unlimited purchase of government bonds from individual euro countries. The refinancing costs of countries such as Italy, Spain, Greece and others had risen so sharply on the financial markets that the countries were threatened with national bankruptcy in the medium term. The main reason for this in Italy was the unsound budget policy and the high level of debt, while other countries were also in dire straits due to the aid to their banking sector. Although the OMT program was never deployed, its announcement of potentially unrestricted government bond purchases by the ECB alone ensured that yields in the government debt markets fell sharply. Ultimately, all countries benefited from this, but this was particularly true of Italy. The Bel Paese, in turn, was one of the biggest beneficiaries of the government bond purchases of the ECB that have been taking place for five years as part of various programs for more than 2.1 trillion euros. Despite its poor credit rating of “BBB”, Italy was able to enjoy yields of currently just 1.7 percent for ten-year government bonds. Countries outside the euro zone with comparably poor creditworthiness pay much more, in Hungary it is 2.8 percent and in Indonesia 8.2 percent.

Italy benefited more than almost any other country from the refinancing costs that were lowered by the ECB - that is, they were not in line with risk and market conditions, even though all finance ministers in the euro countries benefited from artificially low interest rates. As expected, this reduced the incentive for many countries to consolidate their budgets and organize themselves in such a way that participants in the financial markets place more trust in them. After all, lenders want to be able to assume that they will get their money back at some point. Through the intervention of the ECB, Italy has saved tens, if not hundreds, of billions of euros in borrowing costs. That, too, is financial solidarity - provided by the ECB with expressed and unspoken support from the governments in the euro zone.

Solidarity as a one-way street

But solidarity shouldn't be a one-way street. Where has Italy's solidarity been in the last five economically good years? Why has the country not put its finances in better order in order to at least come closer to the criteria of the Maastricht Treaties on European Economic and Monetary Union and to prepare for a potential crisis that always comes unexpectedly? Is it allowed to ask such questions in view of the pictures from the hospitals in Lombardy? In any case, the strategy seems to be paying off for Italy. The proud country remains in the role of supplicant, but new help is approaching. On Thursday evening, a joint financial aid package was agreed in Brussels. In the room there is a “safety net” of over 500 billion euros with three elements: credit lines from the European Stability Mechanism (ESM), a guarantee fund for corporate loans from the European Investment Bank (EIB) and a European short-time work allowance called “Sure”. There is still no agreement on the issue of euro bonds, which are now euphemistically called corona bonds during the crisis.

The liability for euro bonds would in all probability be jointly and severally, which means that in extreme cases a country would be liable for the entire portfolio of these bonds if, for example, all other co-issuers became insolvent. Joint bonds also separate responsibility and liability. This creates even more incentives for all participants to incur unsustainable debt, and there is a moral risk because each individual country enjoys the advantages, but the disadvantages affect everyone. The northerners also fear that they will give the southerners a credit card without a limit because they cannot influence the spending behavior of the countries.

The euro zone has long been a wandering currency union. From crisis to crisis it moves further away from its original idea of ​​a legal community founded and based on treaties without a financial assistance clause between the states. This non-bailout clause was supposed to guarantee the functioning of a monetary union of countries as different as Germany and Italy or Finland and Greece - and that is how it was sold to the people, for example in Germany. The separation of the cash registers should ensure that there are no arguments among friends. However, the hope for such a development was probably naive from the start. Driven by crises, the euro zone is instead moving more and more in the direction of a transfer union.

Damage to independence

The ECB has been making a key contribution to this for years, because the massive bond purchases, the volume of which should be around EUR 3.5 trillion at the end of the year, secure (inexpensive) market access for some countries despite high levels of debt and ultimately favor the implicit communitisation of debts. To put it bluntly, one could speak of euro bonds through the back door, because the central bank holds an ever larger proportion of the government bonds of individual countries. A former chief economist of the ECB aptly speaks of the undermining of the principle of democratic legitimacy by the independent central bank, of all places. That plays into the hands of Europe's populist opponents. Certainly the ECB, as a genuinely joint institution, has seen itself obliged to act in crises in order to iron out the omissions of the inactive and disagreed heads of government in the euro area and to protect the monetary union from even greater political tears. In doing so, however, she has also allowed herself to be instrumentalized by politics and made into a henchman - to the detriment of her credibility and probably also her independence.

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