On March 29, 2019, amid chaos and economic uncertainty in his country, and the European Union, finance minister of Hesse state in Germany, Thomas Schäfer committed suicide. Hesse is home to Germany’s financial capital Frankfurt, where major lenders like Deutsche Bank and Commerzbank have their headquarters. The European Central Bank (ECB) is also based here. Late Schäfer (54), who was Hesse’s finance chief for a decade, had been working relentlessly without much sleep to help companies and workers deal with the economic impact of the pandemic. “Today we have to assume that he was deeply worried,” said Volker Bouffier, Hesse’s premier and a close ally of German Chancellor Angela Merkel. “It’s precise during this difficult time that we would have needed someone like him,” he added.
Germany is by far the strongest economy in Europe with stronger financial resources that has often come to rescue of other European Union (EU) member states during the time of need. Europe, which is now the epicenter of the Covid19 a.k.a. China Virus pandemic is facing a catastrophe with Italy and Spain, two fragile economies, facing the brunt. Spain has joined Italy and France in demanding that the EU do more to help as it reported another record single-day increase in coronavirus deaths and moved to further tighten its already strict national lockdown.
At the time of publishing this article, Spain and Italy accounted for more than half of the world’s death toll from this China Virus and are still seeing hundreds of deaths every day. Spanish Premier Pedro Sánchez has described the crisis as “the most difficult moment for the EU since its foundation” and has urged the 27-member nation bloc to “be ready to rise to the challenge… It’s Europe’s time to act. Europe is at risk.”
Italy’s premier, Giuseppe Conte, has repeatedly urged the EU to show a united and decisive response. “I will fight to the last drop of sweat, the last gram of energy, to obtain a strong, vigorous, cohesive European response,” he had said.
Spain, Italy, and France have asked the EU to issue “Corona bonds” – a collective debt instrument – to help finance countries’ response to the pandemic, but the Netherlands, Austria, and Germany have rejected the idea, thus far. Several European nations have now begun to look at China, where the epidemic originated but is now easing, for much needed medical supplies such as protective masks and testing kits. But after Spain withdrew 58,000 Chinese-made coronavirus testing kits on discovering that they had an accuracy rate of just 30% the Netherlands has recalled over 600,000 Chinese face masks.
The future of the European nation is bleak, to say the least. And with Brexit and the exodus of Great Britain from the union, along with a major global recession in offing, one must doubt if the EU will be able to survive in the post-pandemic world order.
European history, before World War II, has been replete with feuds, rebellions and intra-national rivalry for centuries, one war after another. Doing business across borders was difficult and each time there was a huge cost incurred on “exchange fees” alone. This, of course, was a great impediment to the continent’s economic growth. Post-World War II the businesses and governments felt the desire for a unified Europe.
Eventually, in 1993, 27 European nations signed the Maastricht Treaty and created the European Union (EU). This made business across borders easier but there was one more major constraint – different currencies. The Euro was thus eventually launched on January 1, 1999, as the currency for the entire region, though the British never gave up their currency.
Countries adopting Euro – called Euro Area – discontinued their own currencies, some of which had existed for centuries. They even discontinued their Monitory Policies (MP) giving more powers to ECB (European Central Bank). Yet they had many Fiscal Policies, which became a key reason for the EU’s ongoing debt crisis.
MP controls the money supply in the economy. It also determines interest rates for borrowing money. Fiscal Policy (FP) controls how much money the government collects in taxes and how much it spends. The government can spend only as much as it can collect taxes. Anything above that amount must be borrowed – this is called Deficit Spending (DS).
Before the Euro in countries like Greece, people had to pay higher interest rates to borrow and they could borrow only certain amounts. But when they became part of EU the money, they could borrow skyrocketed. Interest rates dropped from 18% to paltry 3%. There was a general and highly misplaced belief that “if countries like Greece defaulted, the money could be recollected from Germany,” which remained economically prosperous. This was because EU nations were bound by a common currency.
Greece like countries incurred huge debts and for some time even promptly repaid this money with more borrowed money. As far as borrowing continued so did the spending. Such countries also continued expensive welfare and social service payments to their citizens, but now paid for with borrowed money.
Credit flowed debt accumulated and economies in Europe became tightly intertwined, with borrowed money being confused with actual assets or real profit. Companies began opening new factories across Europe. German banks provided lending for French companies. French banks provided the lending the Spanish companies and so on and so forth. The debt was transferred as if it were an asset from one country to another.
This made doing business incredibly efficient and easy. Things continued this way without question since credit was available. Credit was available until the infamous 2008 financial recession when it became clear such credit had no real financial assets to support or sustain it.
As the biggest and strongest economy in Europe, Germany reluctantly decided to bail out the debt-ridden EU countries. But Germany agreed to repay the bills only if other countries would agree to strict “Austerity Measures”. This was to make sure that the problem won’t ever happen again.
Austerity measures meant coming more under control of EU and German banks and never making any more debt-driven spending. It also meant cutting government spending, particularly on social benefits. Since by far the government is the largest spender in any economy when the government stops spending it can hurt many of its citizen’s income. People lose jobs, they get angry and they riot in the streets. Since the government collects taxes based on people’s earnings when earnings are reduced the government collects less in taxes. So, they can only less repay their debts.
Yet there does not seem to be an easy alternative to austerity as continued spending based upon borrowing from other countries does not lead to a healthy economy either. In short, the financial quagmire created does not seem to have an easy or even perhaps a real solution, unless there is some radical change in how business is done.
There are a lot of cultural differences between Germany and other debt-ridden EU nations. Germans are financially responsible. After terrible hyperinflation Germans experienced during World War I, the nation has been very inflation averse and careful about spending and borrowing. In simple terms: Germans work hard and expect little in retirement benefits and they meticulously pay their taxes.
Many debt-ridden EU nations, on the other hand, like other Europeans who live in countries with strong welfare states, expect generous state benefits and don’t pay taxes. Such debt-ridden states have never collected the majority of its taxes it has imposed on its citizens. Germany disagrees with this attitude. Germany’s argument is “If you want our money, you’d need to follow our morals.”
As debt-ridden countries are headed towards default, the whole continent of Europe is in danger as all these economies are intertwined. Even though economies of these debt-driven countries are relatively small it is posing a great challenge since the European financial system is so interconnected – precisely because of the Euro.
The problem is: even if debtor nations adopt austerity measures, and a bailout from Germany and other nations pay their debts and avert the crisis there’s no system in place to prevent this from happening again. The ongoing Chinese Virus pandemic is only making this situation obvious.
The post-pandemic era will require Euro Area to have a fiscal union to match its monetary union. This means there needs to be in place a political authority to impose fiscal policy across the Euro area. It must have the power to cut spending, raise taxes and even set laws. A fiscal union may also prevent excessive borrowing and spending.
However, this is an enormously complicated as well as unpopular notion. This means surrendering the sovereignty of individual member EU nations to higher powers – making the EU into the United States of Europe. Who or what country would be the prime power in such a situation? Likely Germany: owing to its financial strength, but few European countries would like to come under German fiscal domination particularly given the two world wars of the last century. Yet even without such a union, Germany remains the dominant country in Europe.
In decades past the Germans have been benevolent in bailing out defaulting nation’s debts. But whether the German populace will continue to allow such generous measures in the post-pandemic era at their cost is now a question. The German economy has too much to bear. Their reluctance to support “Corona bonds” is well-understood by any sensible economist. But without Germany’s support, the European Union will obviously collapse.