EU Stimulus Fakery as Brexit Stumbles Forward
We’ve been neglecting Brexit and EU stimulus measures because they seem all to familiar, in a bad way. Nevertheless, the EU, just like the US, is grappling with a massive deflationary shock. And even though much of Europe should be able to get to some semblance of normalcy sooner rather than later by virtue of many countries getting lockdown religion earlier than the US (and perhaps also generally taking it more seriously; overwhelmed hospitals in Italy might have focused a few minds), the new normal is going to shrink a lot of sectors, perhaps permanently: conferences, business travel, tourism and leisure travel, restaurants, spectator sports, restaurants and bars, higher education. And then you have secondary damage, such as less activity in business districts due to companies deciding to keep employees working remotely if possible, which in turn hurts nearby retailers and food venues.
As we’ll discuss, the EU, having managed to stumble through the financial crisis and then rolling national funding crises, has become conditioned to think that extend and pretend in combination with 11th hour, bare minimum bona fide action is a successful way to deal with Big Problems. They may be about to find that they are engaging in what we’ll call the Turkey Fallacy. As Nassim Nicolas Taleb pointed out, the turkey has the greatest confidence that the farmer is his friend, in the form of the most observations of the farmer feeding and housing him, the day before his head is chopped off. Or to put it another way, EU leadership has finally encountered a situation where stumbling through it will leave too many important constituencies unhappy, or worse, damaged.
And if all that isn’t bad enough, another hit is coming in the form of Brexit. Both parties are not just sticking to their guns but also escalating no-deal rhetoric and planning.
The very short version of Europe’s (and most of all, the Eurozone’s) big institutional failure, which is now stymieing making an adequate to the coronacrash, is its inability to engage in sufficient fiscal spending. A long list of familiar structures and beliefs conspire together to produce this outcome, including but not limited to a visceral fear of deficits, and as a result, a dogged commitment to austerity despite its repeated failures; misguided faith in “labor market reforms” as in crushing labor, as a way to make austerity work; the lack of meaning EU level spending to buffer the differences in growth reasons, with the result that the ongoing gap between the “debtor” countries and the well-off “surplus” countries is a centrifugal force; too often dopey and self-defeating rescue mechanisms, like the Bank Recovery and Resolution Directive which is better at creating bank runs than stopping them.
The latest effort at (mainly) optics over substance is the much-ballyhooed €750 billion package. Merkel and Macron had gone public with the idea that the two had agree to go big in tackling the downdraft. Germany behaving out of character plus the German-France axis usually carrying the day was taken up by the press as a major move, when our David encouraged readers to lower their expectations on May 19, right after the scheme was first mooted:
It hasn’t had much exposure in the Anglo-Saxon media (though here’s a report from the Guardian) but Merkel and Macron gave a joint video press conference yesterday, announcing a proposal for a €500Bn rescue fund, which would be added to the EU budget, rather than being repaid by the states benefiting. A typical reaction is this editorial in Le Monde, which talks of “a new start for France and Germany” and a front page story about “relaunching Europe.”
The politics of this are significant. Historically, the Franco-German “couple” was described as “the motor of European integration.” It largely depended on personal relationships between the leaders, and these took a severe turn for the worse under Sarkozy and Hollande, and Macron, as the truest of true believers, was keen to relaunch it. One important function of the original EC of course (as with NATO) was to allow the rapid re-entry of Germany into the international system, but under supranational control. This was accompanied (from the 1962 Elysée Treaty) by a bilateral relationship which was politically dominated by France, and for a long time the French managed to manipulate the Germans politically by playing on the sense of guilt of the German political class. This started to fall apart after 1992, when Mitterrand made the disastrous decision (in retrospect) to concentrate on the political side of the nascent EU, and to let the Germans largely have their way on the economic side. Over the last generation, the boot has changed foot quite spectacularly, and one of Macron’s major priorities has been to reduce German dominance. To the extent that this initiative originated with Macron (at least that’s what’s claimed) then if it’s adopted it will be seen by everyone as a slight but significant rebalancing of relationships.
Even if the politics are promising, the EU still needs heavy duty spending. And was that really in the cards? As Clive pointed out:
Yes, you really have to look under rocks to find it. Here’s the FT’s take https://www.ft.com/content/c23ebc5e-cbf3-4ad8-85aa-032b574d0562 (which I had to click through from the homepage, through “world” then down into the nether regions of “Europe” to eventually find).
I suppose it (the “ho-hum” reaction) is mainly because it is, as the FT’s headline states, a “call” for Doing Something rather than an actual Doing Something. And the Usual Suspects were making the usual mooing noises (again, from the FT):
However, the Franco-German plan also met resistance. Austrian chancellor Sebastian Kurz said he and his Dutch, Danish and Swedish counterparts were only prepared to accept a rescue fund that gave out loans.
So the usual monetary “how many angels can fit on the head of a pin” difference between “loans” and “grants”. Plus of course the numbers, even if we take €500bn at face value, are an entry point. Italy’s banks could probably swallow that as a starter, let alone it being the main meal.
But at least they’re trying.
The Financial Times engaged in some cheerleading on May 21 via an op-ed from the head of a New-York based data analytics and macro research company:
But just as the PEPP QE was starting, and markets were healing, the German constitutional court started to moan about the ECB’s QE. It needed to be restricted, the court argued, just like the previous incarnations of QE.
And the euro was back in crisis mode, and we saw the usual widening of bond-yield spreads, especially in Italy. The existing backstop infrastructure was insufficient; there was a lack of political will to create more policy space; and the legal challenge from the Karlsruhe court threatened to make things worse.
Then we had a surprise press conference on Monday from Ms Merkel and Mr Macron, outlining a plan to create an additional €500bn of spending power, via EU-level borrowing to distribute money in the form of grants….
The upshot is that May 18 2020 could turn out to be a historic day in the evolution of the euro. So far it is just a proposal….
But this is a crisis, and we do need a big response. If the grant portion were to get cut to, say, €200bn, it would not be enough to give the market confidence, and it could actually turn out to be very costly — in the form of a bigger European recession — including for the most frugal member states themselves….
The key point is, that if Ms Merkel and Mr Macron can get the entire EU-27 on board, it will move markets significantly. The euro will recover from its multiyear lows versus the US dollar, the Swiss franc and the Japanese yen. Peripheral spreads can narrow notably. And European stocks may finally attract some foreign interest, after a multiyear lull, and deliver some rare outperformance.
I don’t find it terribly confidence-building to see the only benefits listed as ones to financial assets.
Today, Wolfgang Munchau threw some cold water on the plan, pointing out that the numbers are too small to amount to much stimulus. Even though I am a newbie to EU budgeting, it should have occurred to me that the EU uses the same headline gimmickry as our Congresscritters, of taking all the spending contemplated in a bill (or over the next ten years, whichever is longer) and depicting the sum of all those years’ spending as the amount deployed, when it would be natural to assume the figure is first year total.
Bear in mind that Munchau was very sound before and during the financial crisis, but was off the mark on the Greek bailout negotiations. Nevertheless, his assessment here seems well-founded, and I trust any readers who disagree will pipe up. From Munchau:
Some celebrate the European Commission’s €750bn budget increase as a “Hamiltonian moment”, in reference to the first US Treasury secretary who brokered a historic compromise in 1790 for America’s federal government to take over the debt of the states. Others dismiss it as too little, too late. Neither of these views captures its true nature.
I have noted that commentators and Brussels-based journalists often fall for big headline numbers that conflate categories such as grants, loans and spending capacity. The commission is a willing accomplice in this obfuscation. The official document that accompanied last week’s announcement lists the total investment that could be generated as €3.1tn. Numbers like these are meant to impress the gullible. It’s the statistical sleight of hand you might expect from a disreputable election campaign.
The commission says that €500bn of the proposed €750bn comes in the form of grants, and €250bn in loans. The loans are economically irrelevant, since there is no shortage of low interest rate borrowing for the private sector. The grants are what matters.
But beware. Not everything that is called a grant constitutes a fiscal transaction. Some of these grants are used to generate lending. By my calculations, the fiscally-relevant part of the package is a little over €400bn. Of that, the main part is the recovery fund, worth €310bn over four years, plus an extra €11.5bn this year.
Dividing the €310bn recovery fund equally over four years, I arrive at an annual fiscal boost of 0.6 per cent of the EU’s 2019 gross domestic product. This is not nothing. But if you still want your Hamiltonian moment, you will have to look elsewhere.
Ouch. Not only is this not terribly meaningful in terms of EU relations or budget constraints, it’s also pathetically small in relationship to the coronavirus-created economic sinkhole.
And the Brexit freight train continues to bear down at full speed at the EU and UK. Since virtually nothing the EU has said seems to have gotten through to the UK negotiators, Barnier has become even more blunt. I can’t imagine he’s gone off the reservation in becoming so pointed, so I assume he either has license or has been told to signal EU exasperation (which is not news; sources like Politico have been mentioning it regularly for at least nine months). Barnier warned of a no-deal Brexit thanks to the UK walking back major commitments in the Political Declaration. More from Euronews:
After almost three weeks, Brexit talks are back on Tuesday….
In an interview to British newspaper The Times, the EU’s chief Brexit negotiator Michel Barnier said that “the UK has taken three steps back from the commitments it originally made”, adding that the EU wants the UK to respect them “to the letter”…
“We are much less exposed than them because only 7% of our exports go to the United Kingdom, when 47% of British exports go to the EU,” he said.
In another sign as to how sour things have become, fishing, which was seen as a contentious but soluble problem, looks more and more like an impasse, according to Politico.
The Telegraph, relying on the UK’s political funhouse mirror, presented that as Barnier trying to deny the UK its Brexit. And the Brexit fans are particularly steamed up that Sadiq Kahn wrote a letter to Boris Johnson pleading for a Brexit extension.
Before: Brexit will be easy, the EU will give us a great deal. This proves Brexit is a good idea.
After: Brexit is difficult, the EU won’t give us a great deal. This proves Brexit is a good idea. https://t.co/CJzu3y21kV
— Chris Grey (@chrisgreybrexit) May 31, 2020
Plus ça change. Would have meeting after meeting w/ manufacturers, universities, charities, you name it. None wanted Brexit. All wanted single market, and very, very, very few prepared to say anything publicly for fear of the political reaction. You say nothing, you get nothing. https://t.co/YTaBLQxLmL
— Seb Dance 🌹🇪🇺 (@SebDance) May 31, 2020
Why would you pile the effect from Brexit, especially a disorderly Brexit, on top of the effect from the coronavirus crisis. Effects add up and become from mild to medium and medium to severe. #FocusOnSavingLives @BestForBritain pic.twitter.com/6wJIdCUwbO
— Alex Andreou (@sturdyAlex) June 1, 2020
Needless to say, Brexit on top of a coronacrash is like pouring acid on a gunshot wound. I really wish there was a way to steer out of this trajectory but I can’t see how.