The European Union Still Hasn’t Considered an Economic Proposal That Can Save It

Yves here. Marshall Auerback continues with his explanation of why claims that the European Union has taken a big step moving toward fiscal integration and is muscling up to tackle the collapse of economic activity are all wet.

By Marshall Auerback is a market analyst and commentator. Produced by Economy for All, a project of the Independent Media Institute

On May 5, Germany’s constitutional court ruled that parts of the European Central Bank’s bond buying operations to avert a mounting economic depression were illegal. In the wake of that decision, many new proposals have surfaced. First, the European Central Bank (ECB) added a further €600 billion to its earlier announced pandemic emergency purchase program (PEPP) to support Europe’s rapidly faltering economy. This brings the total bond buying up to €1.35 trillion. Additionally, a €500 billion “Next Generation” recovery fundwas introduced by the governments of France and Germany, a figure that was later increased to €750 billion by European Commission (EC) President Ursula von der Leyen.

The numbers behind these programs sound impressive, but taken in aggregate, the proposals simply tweak the legal and fiscal status quo. The ECB proposals blithely ignore the problematic legal issues raised by the May 5 German constitutional court decision. And the Next Generation fund, although on the surface not suffering the same legal deficiencies as the ECB’s actions, is insufficiently large to yank the EU out of its COVID-19 depression, which will require trillions of euros to compensate for the lost economic output, not billions. Almost daily, the continent is experiencing record collapses in economic output—even powerhouses like Germany, as well as the periphery nations of the south. The problem is that at this stage, the EU can ill afford any more baby steps if it wants the European Union to survive as a workable political construct, or the euro to survive as a viable currency.

The Franco-German proposal in particular has been described as “Europe’s Hamiltonian moment,” which is about as accurate a characterization as comparing the dabbling of a five-year-old finger painter with the works of Claude Monet. Both activities might be crudely characterized as “painting,” but that’s about as far as the comparison goes. The original “Hamiltonian moment” was a “historic constitutional compromise forged by the first U.S. Treasury secretary Alexander Hamilton, James Madison, and Thomas Jefferson” in 1790. The parties accepted the concept of debt mutualization by agreeing that the newly constituted federal Treasury would assume all the existing debtincurred by the U.S. states during the War of Independence.” In exchange for the acquiescence of the Virginians, Jefferson and Madison, Hamilton agreed to move the nation’s permanent capital from the north to Washington, D.C. Until that compromise was reached, Congress had been at a political impasse.

Breaking the logjam “made possible the passage of the Residence and Funding (Assumption) Acts in July and August 1790” that allowed the state debts to be federalized. But the compromise did not create a new Treasury or governing structure. That spadework had already been done. The Constitutional Convention gathered in 1787, and the delegates’ handiwork in the form of a new constitution was ratified in 1789. This laid the foundations for a true fiscal transfer union as it gave the national government substantially greater fiscal powers than had existed under the old Articles of Confederation.

By contrast, the Treaty on European Union (aka the Maastricht Treaty) is a framework that more closely approximates America’s discarded Articles of Confederation. Much like the former American colonies, under the Maastricht Treaty, fiscal powers largely remain the provenance of the state governments; minimal centralized taxation and spending powers exist for the EU as a whole. The European Commission (which will manage the recovery fund) still needs unanimous approval from the EU member states to carry out its functions under the new proposals. And the composition of grants relative to loans is still yet to be determined. Four of the smaller member state governments in the north—Austria, the Netherlands, Sweden, and Denmark—have all indicated a preference for the funding to be allocated in the form of loans, rather than outright grants. But piling debt on top of existing heavily debt-laden southern countries such as Italy or Spain effectively diminishes any tangible benefits these countries stand to receive, as the bulk of their fiscal efforts will be devoted toward debt repayment, as opposed to economic reconstruction. This has been effectively another lever of power of the EU’s northern states over the southern ones, as well as a huge growth constraint.

The Next Generation fund would empower the EC to borrow on its account, which has led the proposal’s supporters, notably global investment research firm Gavekal’s Anatole Kaletsky, to claim that it creates a new class of eurobonds, and therefore, “might be remembered as the moment when Europe became a genuine political federation.” A closer look at the details tells a different tale. As Sony Kapoor, managing director of the think tank Re-Define, points out: “The European Commission already has €52 billion of bonds outstanding.” In other words, it’s not a new class of bonds, just a bigger amount. Kapoor also rightly notes that:

….the recovery fund does not… make provisions for a permanent increase in the EU’s meager budget or give the Commission the ability to raise its own funds. Nor will existing debt be subsumed into a fiscal union as Hamilton did. Not even the responsibility for the new debt being created will be shared jointly among all EU countries, as the now-abandoned initiative for ‘coronabonds’ proposed.

In other words, there is no mutualization, no new fiscal treasury, but rather a temporary augmentation of the EC’s existing budget and, even then, one that is not big enough to engender economic recovery. The proposal envisages raising the European Commission’s budget to 2 percent of EU gross national income, hardly sufficient given that Italy, Spain and France are all likely to sustain double-digit contractions in GDP this year. And the proposal would be hardly an exercise in nation building, as all of the countries will be battling each other for the few scraps available on the table.

Unlike the latest ECB announcement, the Next Generation proposal at least has the virtue of being structured with a view toward avoiding potential future legal challenges, precisely because it does not mutualize existing national debts. And the fact that it has Germany’s backing is not insignificant. Jörg Kukies, Germany’s deputy finance minister (and one of the architects of the initiative), explicitly acknowledged that true European sovereignty could not evolve “as long as fiscal union remains incomplete.” But the fact remains that this particular structure does not really advance that cause (even Kukies himself acknowledges that the Next Generation fund does not mutualize national debts). The new initiative likely passes legal muster but at a cost of failed economic effectiveness.

In regard to the ECB, the central bank’s proposed increase to its previously announced PEPP program ignores the fact that the European Court of Justice (ECJ) has yet to deal with the problematic issues raised by the May 5 constitutional court ruling in Germany. Absent clarification from the ECJ, the central bank’s ability to carry on its bond buying activities is therefore constrained. The implications of that judgment are simply being ignored, even though, in the words of Deutsche Bank’s former chief economist Thomas Mayer:

The ECB has no legal or democratic mandate for what it is doing, and it is giving the false impression that there is a free lunch. We are heading for a constitutional crisis in the European Union and there are no means for diffusing it. The euro is simply not viable and the next couple of years are going to determine whether it all breaks apart. The markets don’t understand what is happening.

The markets might soon wake up, however, given that the Bundesbank (which purchases German government bonds on behalf of the ECB) will be prohibited from taking part in bond buying operations from August onward unless the ECB can meet the German constitutional court’s objections.

Perhaps the ECB assumes that by August the issue will be resolved by the European Court of Justice. However, the questions raised by the German court will almost certainly be pursued in future challenges, if for no other reason than there are other legitimate grounds to challenge the activities of the ECB.

The recent German court decision contested the ECB’s sovereign bond buying operations on the basis that they breached the treaty’s proportionality principle (i.e., the ECB’s actions were not commensurate with its stated monetary policy objectives), as opposed to making the argument that the central bank’s actions violated its “no bailout” clause. On the face of it, however, the latter is an even stronger basis on which to challenge the ECB’s actions. It is hard to look at the ECB’s bond buying activities under any objective basis and suggest that they do not violate the “no bailout” provisions of the Maastricht Treaty, because in the absence of the ECB’s purchases, these countries would certainly go bust.

Herein lies the paradox: In economic terms, as the sole issuer of the currency, the ECB is the only entity keeping the single-currency member states solvent. However, as Wolfgang Munchau has highlighted, “the monetary union owes its survival to successful rule-bending. It was a masterpiece of legal engineering in the last crisis to set fire to a no-bailout clause in European treaties, and then create a bailout umbrella on its ashes.” Calling these actions daily liquidity management or reserve maintenance procedures does not disguise their underlying illegality.

At some point down the line, a direct legal challenge will be framed in these terms, whether from Germany or some other member state. In the meantime, the legal ambiguity of the ECB’s status restricts its ability “to respond to a crisis with appropriate size and timeliness,” as Kapoor concludes. That is a huge problem, given the ECB’s unique currency-issuing function and its effectiveness hitherto in staving off mass insolvency and a likely evaporation of the euro.

Ultimately, what is required is a proposal that operates in accord with existing EU institutional arrangements, and which also are consistent with the recent German court ruling. Per capita distributions to the various nation-states via ECB would fulfill this requirement, as this activity is aligned with existing treaty provisions and, most importantly, is consistent with the proportionality principle.

Why? As I have argued before:

[Germany’s] fundamentally strong position vis a vis other member states wouldn’t change, much as per capita distributions from Washington don’t fundamentally alter the relative economic positions of California versus, say, Arkansas. The distributions would effectively amount to swaps of national debt for reserves, which in turn would immediately adjust national government debt ratios downward (because as an accounting matter, reserves are not counted as national debt). This goal would be to dramatically ease credit tensions and thereby foster normal functioning of the credit markets for the national government debt issues. The governments in turn could use this newfound fiscal relief to pursue fiscal packages that revive their domestic economies (as opposed to using the mechanism for covert bank bailouts).

The EU’s Big Need

What is required is a bit of creativity and real statesmanship to ensure that policy is not perpetually subject to irrational austerity constraints, or endless court challenges because of monetary improvisations that mask illegal activities. Per capita distributions from the ECB may not sound as groundbreaking as a “Hamiltonian moment,” but that’s the whole point: they are consistent with pre-existing Maastricht Treaty provisions, and they don’t ride roughshod over them. Hence, they avoid time-consuming legal wrangles that would constitute the equivalent of fiddling while Rome (or Berlin, Madrid, Paris) burns. These ECB-led per capita distributions provide the sole possible, reasonable and prudent basis to save the euro, as well as laying a more realistic foundation for a viable fiscal transfer union.

The sooner this is realized by Europe’s main policymakers, the better, because if the courts do ultimately decide to pull the plug on the ECB’s current activities, there will be no safety net left.

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  1. frequent

    Curious question since it is mentioned here regularly: how are per capita distributions to member states not going against EU treaties?

    1. PlutoniumKun

      Capital grant distribution is part of the overall budgeting of the Commission, which is within the treaties, every member signed up to this on joining. The problem now is with the ECB and the architecture of the Euro, not the original binding European treaties.

  2. The Rev Kev

    I wonder if the EU could do a strategic retreat and give up the Euro while keeping the EU membership going. Yes, it will be an enormous hassle and I mean enormous, but individual states might have a chance at printing their own currency and devaluate it to an appropriate level to get their economies going again. Is the Euro a hill that the EU is really prepared to die on?

    They could do it later when the right financial machinery is in place but I do wonder what the EU’s situation would be if there had been no Euro at all. I know that this sounds like a very simplistic, partial solution but it is not like the EU has a lot of options at the moment.

    1. Off The Street

      Maybe the EU isn’t really trying to, and is structurally unable to, solve the problem.
      That Hamiltonian Moment is akin to them putting on a Broadway play about misinterpreted history set to some catchy tunes, and then notifying the world that they were “dancing pretty hard in their seats”. Entertaining but in the end empty exercise.

    2. NotTimothyGeithner

      The political machinery is the problem. Since Hamilton and Madison are the points being mentioned, they changed before a situation where Virginia and NY or PA started throwing tantrums. The US under Articles of Confederation accomplished quite a bit.

      The summation about the need for statesmanship belies that the real problem is the need for federal integration. The real problem is Hamilton and Madison were Washington’s surrogate sons (Madison was close to Jefferson who was still friends with Adams) and veterans of the recent troubles. They had standing to speak for the new order and deep seated investment in the project. It was their project. Jefferson and Madison probably didn’t care about the location of DC, but they needed a “win” for the slave power to weaken Virginia slave power which was seen as a guarantor of slave power in Georgia, the Carolinas, and future Southern expansion. I don’t see Europe having the relative figures or figures of sufficient stature to reform the system in such a stark way. Though the crisis had not yet arrived in the US.

      The Euro is over 20 years old now. It can vote. That’s over twice as long as the time between Yorktown and the start of the Constitutional Order in the US. It’s here to stay outside of a collapse. 25 and under doesn’t remember using a different currency, and the eastern states were in the Soviet blocs.

      The only path forward is trying to get people to come around to a stronger federal government and weaken the control of institutions not directly elected by EU citizens. In a relatively perfect world, two EUs with a unified and small military is probably the most sensible.

  3. Ian

    The EU is too darn slow to be worth it for countries like Italy and Spain. How is the EU going to solve the shit we are in with respect to capitalism when it can’t even solve basic counter cyclic fiscal policy. Whereas China, for all it’s shortcomings, is moving like a well coordinated Marxist beast!

  4. timbers

    IMO, Germany should leave the EU and bring back the Mark, get U.S. troops out, turn east and invest in Russia and forge trade relations with China and Asia.

    Let the rest of Europe be forced to buy U.S. fossil fuels and 4G/5G, chlorinated chicken, GMO grains, RoundUp fruits and vegetables and be occupied by U.S. troops. – if that’s what they really want and are unwilling to restore their sovereignty.

    Of course that might trigger a similar attempt to overthrow German leadership in the way U.S. did to Australia when it’s government leadershop was there one minute, gone the next.

    Overall, this might be a big contributor to world peace…provided the U.S. doesn’t go full Roman Empire and lash out as it sees itself crumbling.

  5. Sound of the Suburbs

    How did the Euro-zone get into the mess it’s in today?

    Well, no one really knew what they were doing with neoclassical economics before 2008.
    Everyone cheered as economies boomed on borrowed money, e.g. the Irish Celtic Tiger economy.
    No one realised Wall Street was flooding the world with toxic assets.
    “It’s nearly $14 trillion pyramid of super leveraged toxic assets was built on the back of $1.4 trillion of US sub-prime loans, and dispersed throughout the world” All the Presidents Bankers, Nomi Prins.
    The periphery nations boomed on money borrowed mainly from the banks at the core.
    The big European banks loaded up on Wall Street’s toxic assets.

    The Titanic was heading straight for the iceberg.
    The neoliberal designers of the Euro-zone had expected perfect markets to ensure none of these things happened.
    Nations didn’t have their own central banks to backstop national financial systems when a financial crisis hit as this wasn’t seen as necessary.
    The Titanic hit the iceberg and there weren’t enough life boats.

    Neoclassical economics, probably the worst economics in the world.
    (I bet they drink Karlsburg – probably UK only joke)

    “We cannot solve our problems with the same thinking we used when we created them.” Albert Einstein.
    Who do you think you are?
    This is what we are going to do, whether you like it or not.
    He must be one of those populists.

    Einstein is quite right of course.
    Things go from bad to worse in the Euro-zone.
    Policymakers that use neoclassical economics tend to think austerity is the answer, and they did in the 1930s as well.
    Policymakers couldn’t remember what happened when they used austerity in the 1930s, it’s a really bad idea.
    Recommended reading “Austerity, the History of a Dangerous Idea” Mark Blyth.

    Western policymakers are completely clueless about the mechanics of the monetary system and there was no way they could see the problem with austerity.

    The IMF predicted Greek GDP would have recovered by 2015 with austerity.
    By 2015 Greek GDP was down 27% and still falling.
    The money supply ≈ public debt + private debt
    The “private debt” component was going down with deleveraging from a debt fuelled boom. The Troika then wrecked the Greek economy by cutting the “public debt” component and pushed the economy into debt deflation (a shrinking money supply).
    Greece was pushed into a Great Depression type event by the Troika.

    That will do for now, I am sure you’ve got the idea.

  6. Susan the other

    It does sound like there is middle ground wherein “per capita distributions” are in the same spirit as an “umbrella”. It’s like the only objectionable “free lunch” is where only a few spendthrifts get it while the rest go on a diet. So this is sounding reasonable. Fiscal spending is ultimately very reasonable – per capita politics. I was puzzling about Germany and France planning to borrow money for their own economies in the various “money markets.” But how does that occur when money is tapped out – well it happens with any number of emergency accounting agreements for distributions from central banks to lesser banks to national banks and etc. Right? So in the end the only thing that is really there is a bailout. Northern EU countries wanting debts, not grants, is just the long way around. And it all seems to rhyme with George Soros’ latest suggestion for perpetual interest-only bonds – like the income stream is the thing for all the old die-hard neoliberal financiers. So if after the 100-year or “generational” bonds have been finally “run-off the books” without any principal being accounted for – isn’t that like an imperceptible “evaporation” of all those fearsome excess euro? The incredible lightness of money? Can’t have all that potential inflation of a nonexistent mythical value screwing up anybody’s hoards of tokens.

  7. Scott1

    Warren Mosler recommended that Italy issue its own currency again. He said that it would be used for domestic buying and selling. He said that those holding Euros could keep them. He said that this basically would fix the problem created by the Euro which is an immature currency.
    Churchill envisioned a United States of Europe. It is as though the financial system was the last thing thought of. The UK was in the best position of the EU nations since it did not adopt the Euro. Apparently UK citizens didn’t like laws of one sort or another coming their way from technocrats they didn’t vote for.
    The founders of the US were willing to make decisions and many of them were the right decision.
    Nothing works that you do not believe in.
    It is my belief that the founders of the US were pragmatists and it is that that made for systems that worked as long as the spirit of the endeavor was the guiding principle. In the US the spirit of a united states is questionable since so many ideologues and theocrats have raised up agendas antithetical to the spirit of federalism that had the goal of making all of the states strong, together.
    In the sphere of education it has long been that the states educational systems do not provide per capita opportunities. States do not get enough money to provide the citizens a generally high level of instruction, training, and inspiration.
    If the states continue to provide insufficient educations and the reason is they don’t get enough money from the Federal Government they need to issue their own currencies same as Italy ought be issuing its own.
    Let the goal determine the system.

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