Europe’s ‘Hamiltonian moment’

By Jacek Rostowski and Arnab Das

LONDON — The Franco-German proposal for a 500 billion euro European Union (EU) recovery fund to cope with the COVID-19 crisis has been called the EU’s “Hamiltonian moment”. Like Alexander Hamilton’s 1790 agreement with Thomas Jefferson on transferring US states’ Revolutionary War debts to the new federal government, the logic goes, such a fund would pave the way to a United States of Europe. If only it were that simple.

A credible federal fiscal capacity, as Hamilton negotiated for the fledgling US, would ensure the euro’s long-term survival. But before Europe achieves anything close to federalism, it must survive a potential “Fort Sumter” moment, that is, a backlash comparable to the 1861 attack by Confederates on a Union garrison near Charleston, South Carolina.

The Battle of Fort Sumter marked the start of the American Civil War. Can the EU do better?

Until now, COVID-19 has delivered a largely symmetric economic shock to EU member states, with most countries imposing lockdowns of similar intensity and duration. Yet policy responses have been highly asymmetric, with Germany’s fiscal-stimulus plans dwarfing those of southern Europe’s heavily indebted countries. Germany will offer direct fiscal support amounting to 13 per cent of its 2019 GDP, over ten times what Italy is providing. Add to that loan guarantees and tax deferrals, and Germany is delivering support worth a whopping 50 per cent of GDP, four times the amount of economic support on offer in Spain.

Without shared fiscal capacity, only the European Central Bank (ECB) stands between highly indebted member states and skyrocketing borrowing costs. But the need to undertake large-scale bond purchases clashes with the sensibilities of northern European countries, and has spurred accusations that the ECB is exceeding its mandate.

Last month, Germany’s Federal Constitutional Court (GCC) ruled that, unless the ECB can prove that the bond-buying programme’s policy objectives are “not disproportionate” to their “economic and fiscal policy effects”, it will bar the Bundesbank from participating. The oft-heard Brussels quip, “European law is superior to national law, but German law is superior to European law,” has never seemed more apt.

But if the GCC fired the first shots, the European Commission, the ECB, and the European Court of Justice (ECJ) are set to go nuclear, despite the potential for mutually assured destruction. For starters, the ECB Governing Council is expected to instruct the Bundesbank to purchase German bonds anyway, a decision with which the Bundesbank would have to comply, per the EU treaties.

If the German government (or the Bundesbank) obeys the GCC anyway, the European Commission may bring a lawsuit against it. The ECB could also decide to circumvent the Bundesbank, purchasing German bonds directly. After all, in monetary unions, the power lies with whoever prints the money, and in the eurozone, that is the ECB.

How this conflict will unfold remains to be seen, but one thing is clear: The GCC ruling sets a dangerous precedent. If it is allowed to stand, other national courts could start to cherry-pick EU laws, leading to the collapse of the eurozone, the single market and the EU itself.

Needless to say, German Chancellor Angela Merkel now faces a serious dilemma: Challenging the highly respected GCC is politically risky, but acquiescing to its ruling could be catastrophic. It does not help that, with US President Donald Trump committed to his “America First” isolationism, and a post-Brexit Britain apparently eager to sever its remaining ties with the EU, Germany has lost previously reliable strategic allies. Meanwhile, rapidly deteriorating external conditions are threatening the country’s export-led growth model.

For the sake of its economic and national security, Germany should be looking to restart the Franco-German motor of integration, not undermining European solidarity. That is where the proposed EU recovery fund comes in: It can obviate the constitutional crisis that would ensue if Germany doubled down on its challenge to ECB policy and the ECJ’s jurisdiction.

One thing the COVID-19 crisis has made clear is that Germany’s flawed vision for the euro has become untenable. The eurozone can no longer limp along without fiscal underpinnings, and the misguided obsession with “states’ rights” can no longer dominate national politics and fiscal policymaking.

Even former German Finance Minister Wolfgang Schäuble, a longtime advocate of the “states’ rights” approach, is beginning to recognise this. Expressing his support for the EU recovery fund, he declared that, “if Europe wants to have any chance at all, it must now show solidarity.”

Europe could have used this perspective during the eurozone crisis of 2011-2012. At that time, though, Schäuble pushed strict fiscal austerity, which raised the need for ever-greater monetary accommodation and fuelled rising inequality.

Had Schäuble instead recognised, as he does now, that “Germans have an overarching self-interest” in Europe’s recovery, and supported appropriate policies, Europe would have weathered the crisis far better. There may not have been an upsurge in nationalism in France, Hungary, Italy, and Poland. Even Brexit may have been averted. Still, better late than never.

Yet some still have not learned this lesson. The EU’s so-called Frugal Four (Austria, Denmark, The Netherlands, and Sweden) have issued a counterproposal that would strip the recovery fund of its two most important features. First, they would require that support take the form of loans, instead of grants. Second, they would base allocation on conditionality, rather than need. This version would cause debt to skyrocket in the EU’s most fiscally fragile countries, leaving the ECB, yet again, as the only line of defence against speculative attacks.

Central European populists also insist on extracting a pound of flesh, in exchange for agreeing to the recovery fund, which requires unanimous support. Given this, it is worth considering making the initiative a eurozone fund. Countries outside the monetary union, including two of the Frugal Four, could opt in, but they could not block its implementation.

Would this enable the EU to avoid a Fort Sumter moment? Maybe. But the GCC could also deem the recovery fund illegal. In that case, the path to disunion would grow shorter.

Jacek Rostowski is a former minister of finance and deputy prime minister of Poland. Arnab Das is Global Market strategist and a member of the Global Investor Forum and Global Thought Leadership at Invesco in London. Copyright: Project Syndicate, 2020. 

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