Raw Emotion and Unpayable Debt Have Brought the EU’s Simmering North-South Conflict Into the Open

The EU project can survive one economic depression in the blighted South. It cannot survive two.

By Ambrose Evans Pritchard and cross-posted from The Daily Telegraph.

For the last decade Germany and the northern creditor bloc have done just enough in each euro crisis to avert a collective revolt by Club Med debtors.

Action was always too late – and too little to overcome the Original Sin of the EMU construction – but nevertheless sufficient to head off financial Götterdämmerung. The euro remained an orphan currency with no fiscal sibling. The European Central Bank was each time left to do the dirty work and find plausible ways to skirt the EU treaty law.

Pandemonia has brought matters to a head. Emotions have become explosive. It is no longer viable – economically or politically – to keep buying time by piling more debt on southern European states already on the threshold of runaway debt trajectories. The momentous issue of fiscal union has to be addressed once and for all.

“The Italians and Spanish will not forgive Europe and we Germans for a hundred years if we leave them in the lurch, and that is exactly what we are now doing,” wrote ex-vice chancellors Sigmar Gabriel and Joschka Fischer in the Tagesspiegel. 

They invoked the Berlin Airlift of 1948 and the US Marshall Plan, but they also went a crucial step further. The southern states cannot afford to rebuild their economies after the economic holocaust of Covid-19 by raising debt on their own balance sheets. There must be joint debt issuance and debt forgiveness, along the lines of the London Conference in 1953 when half of Germany’s foreign loans were written off – for the good of all.

Unicredit’s latest damage report – “the mother of all recessions” – says eurozone GDP is likely to contract by 13% over 2020 as a whole (Goldman Sachs says it could be minus 16%) and by even more in the South. This will send public debt ratios spiraling up to Japanese levels, both through double-digit budget deficits and through the denominator effect of a shrinking base. But these countries are nothing like Japan.

Italy will jump by 33 percentage points to 167% of GDP,  Portugal to 146%, Greece 219% (disaster), Spain 126% and France 123%. Some of this will unwind next year if there is a V-shaped recovery. But what happens if Europe goes into on-and-off lockdowns or a second wave? What if Italy is forced to swallow loan guarantees – nearing 50%of GDP after the latest roll of the dice this week – and has to nationalise banks.

We can argue over whether Italy’s levels are beyond the point of no return for a sub-sovereign borrower with no monetary levers. Markets are taking matters into their own hands. Italian risk spreads traded this morning at 218 basis points over German Bunds despite massive, Italo-centric, front-loaded, purchases of Italian debt by the ECB since late March

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