Not To Do List (part II): Corona bonds (extended English version)

Pogo dancing (Andreas Bohnenstengel, https://commons.wikimedia.org/wiki/File:Rockabilys_02.jpg)

Pogo in Togo, Corona in Ancona. The anarchic dance through institutions continues. Never waste a crisis! With this in mind, Italy is using the corona pandemic to achieve a sharing of European public debt. European solidarity, instead of domestic Italian solidarity. The Corona crisis has not changed the arguments against sharing debt. Corona bonds result in the lifting of budget restrictions for individual countries, the suspension of fiscal discipline  (otherwise enforced by capital markets) and a downgrading of Germany’s credit rating. This time is different is the dangerous narrative: Italy has slid into the crisis through no fault of its own, the instruments would only be used once and, moreover, Germany will benefit if Italy recovers quickly. So it is anyway in Germany’s self interest. Are these arguments correct or is this just a sham discussion to the benefit of Rome and Berlin?

It wasn’t me!

The corona pandemic was not a black swan. After the Spanish flu, Hong Kong flu, Ebola, and SARS, it was only a matter of time before the next virus would strike. Scientific publications which predict today’s scenario to the point, existed long before Covid-19. Nevertheless, Italy entered this crisis with maximum unpreparedness. With an underinvested healthcare system and no financial reserves. They have relied on their compatriot Draghi and his unprincipled “whatever it takes”. Precautionary saving did not take place. Any crisis would have revealed Italy’s lack of fiscal leeway because Italy has not managed to benefit from interest rates that are far too low for their country and to reduce debt since the EU was founded. Instead the shadow economy was flourishing with no comparison to other countries. This is now falling apart at high speed and Italy’s debt ratio could easily increase to 170 to 180 percent.

No one except Italy is to blame. The tackling of this crisis is easier for countries with strong public finances and credible central banks. Both has been painfully bought through painful reforms and lower consumption in the past. Not in Italy! But even now, Italy is by no means denied access to the capital markets. The implicit protection through the spread governance of Italian and German debt through the ECB ensures Italy lower interest costs than outside of a currency union. Rome still asks for more.

Once is never?

Central elements in economic interactions are credibility and rational expectations. Actions today set expectations for future crises and may deprive economic actors of credibility and thus future ability to act. Michael Hüther from the Institute of German Business (DIW) says: “We are in different, special times”. That’s right, but the same can be said for every crisis. If you allow debt to be shared now, you will have to share it again. What would have changed in the next crisis? This anticipation reduces any incentive to save today, but also makes raising as much (new) debt as possible look attractive. If you agree on splitting the bill in a restaurant, some folks might order an extra large steak and maybe a dessert that they would otherwise have spared. Basically, you correct the idea of the European Union forever. This is the real threat to Europe.

To Germany’s advantage?

Mr. Fratzscher (Ph.D. from Florence) believes debt mutualization is beneficial for Germany and Europe if Italy recovers quickly as a result. Nobody denies that a revovery of the Italian economy would also benefit Germany and Europe. After all, asymmetric economic recovery is detrimental to an imperfect (badly designed) currency area like the euro. Still the argument is not convincing for three reasons:

  1. Fratzschers argument is pure handwaiving. Without a structural economic model this remains a conjecture at best. Formal theoretical work is not what Mr Fratzscher is known for.
  2. We can easily reverse the argument and state that the current German policy actions already benefit Italy.
  3. Most importantly it is in Italy’s own interest to launch an economic and medical restart as soon and as forcefull as possible. Italy has ervery opportunity to do this. Demanding Corona bonds is simply an Italian gamble.

Thanks to the ECB, Italy is granted an advantageous access to the capital market. And if you really believe that “one-off” rule violations have no impact on expectations, you have to vote for a one-off property tax in Italy (forced internal Italian solidarity). Italy pretends it is not prepared to do this. The assets of others are always more desirable. Italy gambles. In reality, it has no other choice. A threat of not reviving its own economy is not credible, because it would be irrational. Italy would see their industries dissappear or taken over at bargain prices. 

Fake discussion

Is it really about life and death as Conte claims? Draghi and Lagarde have long made the citizens of Germany liable. Without democratic legitimation, the ECB has already enforced the sharing of debt. The targeted purchase of Italian government bonds leaves all European citizens liable. If Italy fails to repay its bonds, this is offset either by higher inflation or lower central bank profits. There is no doubt about that. One could almost be inclined to believe that the media discussion about corona bonds was staged to distract from this fact.

Conclusion

Italian citizens do not deserve to die from an inept government. We have to provide them with all possible medical assistance and provide relief supplies and support personnel free of charge. This does not set the best incentives either, but human lives are more important in this acute situation. It would also open the eyes of Italian citizens to whoever is cheating on them. Italy can and must finance its policy actions to protect Italian companies and banks itself. If France wants to bail out French banks holding too much Italian debt it needs to do this by its own, rather than draggin outhers into it. If moral hazard induced by central bank action and political concerns about the future of the Euro is not eliminated, the EU will either cease to exist or end up as a socialist superstate in permanent redistribution. I fear the later.

Instead, funds should flow to developing countries to help avoiding a humanitarian catostrophe. They are actually needed there.