The entire Cold War financial success of the United Kingdom was predicated on its ability to provide Eurodollars to the financial markets – that is, dollars sold in London and thus, critically, outside the regulatory scope of the Federal Reserve. With the coronavirus pandemic forcing central banks into panicked holding actions, moreover, the status of the Dollar as the Global Reserve Currency seems more entrenched than ever. But is that true? Could the Euro challenge this position, and should it?

The Dollar: Lifeblood of International Transactions

To begin with, let us define what a Global Reserve Currency (GRC) actually is. To put it into simple terms, it is the currency which Central Banks and other financial institutions maintain to prepare for financial actions, ranging from investments to variations in domestic exchange rates. Once a currency becomes used as a reserve all over the world, it naturally becomes a GRC.

Hoarding a single GRC has been traditionally appealing: a reserve currency removes the need to exchange currency every time when doing trade. This naturally reduces the exchange rate risk associated with currency exchanges. Since everyone holds the same GRC, they can do trade with the same currency, which helps facilitate investment and other transactions.

All of this global hoarding has a myriad of net effects. On one hand, it generates a massive import of capital to the issuer country; it increases the demand for the currency and hence increases its value; it allows the issuer to hold ”cheap” debt and ”live beyond its means” to paraphrase former French Finance Minister Valéry Giscard d’Estaing’s comment about the United States. Indeed, the endless appetite for dollars has allowed the United States to run a trade and financial deficit of immense scale, since American debt issues always invariably find numerous willing buyers. It has also allowed countries like China and Russia to avoid inflationary pressure on their expanding economies by siphoning money away from the money supply, through the mass purchase of American bonds.

On the surface, this might sound like an amazing deal: everyone else benefits from a stable currency, trade is facilitated and risks are lowered. The issuing country, meanwhile, gains capital and has access to ”cheap” and extensive financing. When one looks closer, however, one notices that not everyone benefits from this windfall. Capital inflow disproportionately benefits financial institutions, causing an increase in wealth disparity and inequality in the issuing country.

Especially in the current economic context, very few people are holding their breaths to see if the wealth will trickle-down. The gain in demand for the currency leads to the subsequent increased value of the currency. This bloated value damages exports and thus hurts the industry. The financial institutions grow wealthier at the expense of the country’s industrial base. While Asian industry keeps taking up more and more market share from the US, the difference between the industrial sector and the financial sector becomes unbearable, particularly as it also eats at the income and job prospects of the working class.

At present over 60% of bank reserves outside the United States are denominated in US-dollars. The picture is similar for global debt, with dollar denominations holding a share of approximately 40%. The thirst for dollars gives no sign of slowing down. In fact, after the 2008 financial crash, institutions around the world began hoarding dollars, a move exacerbated when the Federal Reserve acted as the lender of last resort to save the Eurozone from collapse in 2012. The same hoarding is taking place today, with the world economy reeling from the shock of COVID-19. One could say that the demand for US-dollars has never been higher than now. However, this hasn’t stopped some commentators from sounding the alarm bells.

The Currencies That Would be Kings

Recently Goldman Sachs strategists have warned that the US Federal Reserve’s reaction to the coronavirus crisis may end up destroying the Dollar’s reign as the pre-eminent GRC. The Fed has increased its balance sheet by around $2.8Tn, an absolutely astronomical amount, and has been busy printing money. A GRC requires for itself a certain level of stability, so that it is easily predictable and so that it carries little risk, but financial strategists are warning that the current monetary policy threatens to debase the currency over the coming years. In such a case there is a threat that the savings held by financial institutions globally will be worth much less than what they are now.

This warning has triggered an immediate market reaction. The demand for Gold and Bitcoin (and other alternative currencies) have soared. “Gold is the currency of last resort, particularly in an environment like the current one where governments are debasing their fiat currencies and pushing real interest rates to all-time lows,” commented Goldman strategists. It is important to note that such warnings have been issued before, and historically betting for the Dollar to fail has been a losing game.

For a long time, the Euro was seen as the next GRC, with Euro reserves seeing global growth and prominence at the expense of the Dollar. This progress came to a sudden halt around 2008, in the turbulent onset of the financial crisis. In the decade since, the Eurozone has shown itself to be a relatively unstable economy, which is one of the key qualifications institutions look for in a GRC issuer. This effectively ruled out the Euro’s candidacy for the time being. For the Euro to truly become a GRC it would require great strides from the Eurozone in terms of ensuring that the bloc is stable, including stricter financial controls and some form of internal debt mutualisation system, both of which are unpopular ideas within the bloc, albeit amongst different groups for each.

China, with their Yuan Renminbi (RMB), is the other natural contender to the status quo. For China, becoming the issuer of a GRC would be a chance to garner more financial independence as their trade would no longer be tied to US dollar issuance – although an alternative policy would need devising to contain inflation. In essence, getting onshore currency from the US is excessively easy. The idea of limiting dollar exports has been raised by some, but it has been noted that this could have catastrophic effects on US inflation rates. China has a myriad of other reasons to become a GRC. It would lower borrowing costs, increase Chinese prestige around the world, support Xi Jinping’s reform efforts, spread exposures of the RMB around the world and finally allow China to become a price setter.

All of this would support the CCP’s goal of creating a multi-polar world where the USA would no longer be a sole hegemon. This drive towards a greater prominence of the RMB has been built on increased Chinese market share of global trade and the addition of the Yuan renminbi into the IMF Special Drawing Rights basket – the basket of currencies which count towards the official reserves of nations. The SDR used to be tied to gold but is now tied to a basket of five major currencies.

The Yuan, however, still faces considerable difficulties. The currency is not fully convertible, the onshore version is hard to come by and no trade-safe asset is available. While both the RMB and Euro have become the reserve currencies of their respective regions – much of the non-EU European countries holding the Euro as their main reserve currency, and Chinese neighbours holding the Yuan or the Japanese Yen – there are significant obstacles for them to reach the status of GRC, even in a multi-polar system.

For the Euro, there are high risks in terms of prestige and economic policy. For example, if China were to peg the Yuan to the Euro, this would have severe implication on the value of the currency and on Europe’s ability to command their own monetary policy. At the same time, the ensuing over-valuation of the Euro could be catastrophic for the European industry, as the currency is already overvalued for much of the union – with the notable exception of Germany. This would also increase wealth disparities and most likely lead to social disruptions.

With all of these considerations in mind, elevating the Euro to GRC status would still lead to higher financial independence for Europe. Whether or not the Eurozone would be ready for the necessary reforms to push through a plan for a GRC – or whether it would even be smart to do so – is still questionable, although the promise of prestige may often be popular among federalist circles.

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Upsetting the balance

Heating tensions have been around for a long time, but we can pinpoint the 2018 G7 summit as the catalyst which triggered the worst of the conflict. The US’s aggressive, almost neo-mercantilist, trade policy headed by the Trump administration has placed the land of the free at odds not only with China but also with the EU and a number of African nations such as Rwanda.

What started as a US-China trade war has now evolved into a US-EU dispute as well. The US wanted the EU to support the US in their trade war against China, by limiting Huawei networks and joining in the USA’s sanctioning and admonishments of the actions of the CCP. On the other side of the Atlantic, though, China and the EU saw an opportunity to unite against Trump’s aggressive trade policies and began setting up negotiations to form a unified front against the US in trade issues.

However, Europe soon found that even a common enemy wasn’t enough for China to adopt fair trading practices. Currently, the European Commission’s web page on trade policy has a civil, yet telling paragraph: “The EU is committed to open trading relations with China. However, the EU wants to ensure that China trades fairly, respects intellectual property rights and meets its obligations as a member of the World Trade Organization (WTO).”

The text very politely implies that the EU doesn’t think that China trades fairly. Indeed there are deep problems with trading in China, everything from the legislation allowing China to exercise control over private companies to mandating that foreign companies have a designated national connection in China before they are allowed to do any business in China.

The EU has until recently allowed Chinese companies to operate relatively freely in the EU, just like other international companies. With no improvement of fair trading conditions in sight, now even the EU has had enough and has begun targetting Chinese companies much like China has targeted European ones, and it is China’s turn to complain. Reciprocity wasn’t supposed to be on the menu.

Will US-EU Trade Relations Keep Deteriorating?

The fallout between the EU and China could (and should) have opened up a pathway for Western powers to mend their broken relationship and form a renewed Trans-Atlantic front. Instead, earlier this year the EU-US trade dispute flared up with new tariffs.

At the end of 2019, the Trump administration announced that it would be placing higher tariffs on a multitude of European goods, especially alcohol and foodstuff – hitting a myriad of products with a 100% tariff. This came as a reaction to the EU’s illegal support of Airbus as well as France’s planned 3% digital tax. Later, in January 2020, France agreed to freeze the plan, as nearly 140 OECD countries negotiated new international tax plans to better account for digital giants like Facebook, Google and Amazon. However, as the COVID-19 drug and vaccine manufacturing disputes arose, France announced it would once again go ahead with the tax plan, which prompted the US to hit the EU with another barrage of tariffs.

Now, while the EU has also responded with a number of retaliatory tariffs on the US, it is possible that European leaders will yield to the US to protect their relationship with the EU’s largest export market. There is a long-lasting bias for favouring exports and demonising imports – stemming from the mercantilist age. This mode of thinking has lasted in the minds of policymakers.

Economics and trade are not so one dimensional though. They cannot be summarized as “exports good, imports bad”. This sort of autarkic way of thinking has caused many nations – from Fascist Italy to the Soviet Union – an endless amount of trouble in their time. Many modern businesses are built around international trade – many of them require imports to function and impediments to imports may cause them to fail, thus negatively affecting the national output of the importing nation. Showing that wealth can be generated from imports.

Looking Ahead

The US and China managed to arrive at a deal settling their trade differences at the end of 2019, which made many hopeful that this would be the end of the year-long conflict. Unfortunately, as the COVID troubles heated up, the trade war heated with it. The US has mounted attacks on China from within the international community, berating them for their early cover-up of COVID and eventually leading to the US exiting the WHO.

At the same time, China has been attempting to bring Hong Kong under control, which has prompted a fresh line of criticism towards the CCP. With the alleged genocide of the Uyghurs, the CCP has seen its fair share of criticism this year. However in a twist of fate, while these wars of words have gone on, both countries have been forced to exempt many of the tariffs they placed on each other out of necessity, as they’ve found that the current situation has increased the need for imports.

The danger in the trade wars between the US and China (and EU and China) is that decoupling economies in this day and age is horribly difficult, and possibly recession inducing. The same warning has been levelled about an EU-US trade war.

The COVID-19 crisis may have put a stop on any major changes in the trade war situation, but it is very possible that after the worst is past the US and China will once again slip into a trade war. While the EU-US war rages on and an EU-China trade war looms over the horizon, pitting each other’s largest trade partners in a cycle of trade battling risks closing Europe into a true Mexican standoff.

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Eurogroup finance ministers agreed on a 540 billion-euro package to be used at the European level as financial firepower; the text also foresees a future Recovery Fund that will be financed through “innovative instruments”. The European Investment Bank (EIB) will guarantee loans of 200 billion euros with a focus on small and medium-sized enterprises. The funds to draw from the European Stability Mechanism (ESM) amount to a maximum of 2% of each Member State’s GDP, meaning that 240 billion in total could be employed. The Eurogroup also welcomed the Commission’s proposal for a “Support to mitigate Unemployment Risks in an Emergency” (SURE), a loaning scheme providing up to 100 billion euros to help rescue workers and their jobs.

During the negotiations, the Netherlands did not buckle over Eurobonds, an instrument that according to the Dutch finance minister Hoekstra “will not help Europe in the long term”. The Netherlands, however, had to concede over the conditions of the ESM fund: loans targeted to cover healthcare-related costs will come with no strings attached, while conditions would be applied to revive the economy.  Eurobonds (dubbed coronabonds amid the current crisis) were originally advanced by Italy, Spain and France and six other Member States in a letter sent to the President of the European Council Charles Michel.

Many citizens welcomed the agreement negatively. In Italy, calls for Italexit are mounting while some European citizens display concerns over the real use of the allocated funds by the most indebted countries. To clarify the most salient points, here are three key takeaways from the Eurogroup’s negotiation:

1 – This outcome was to be expected: Eurobonds are a sensitive issue

The issuing of Eurobonds could take different shapes and modalities. However, a core pillar of the concept is that these new financial obligations would be jointly guaranteed by the Eurozone countries and issued by a supranational or intergovernmental institution. Being guaranteed by fiscally sound countries as well, these new obligations would decrease the borrowing costs for governments, primarily benefiting highly indebted countries.

The Commission already proposed several forms of Eurobonds in the past, but it was met with timid responses from countries such as Germany, the Netherlands and Finland. While it is not clear what effect Eurobonds would have on the existing debt, some economists argue that borrowing costs would converge, meaning that countries like Germany would lose out of the initiative. Moral hazard and free riding constitute another concern. Northern countries and fiscal conservatives fear that inefficient governments could take advantage of these bonds to overspend and avoid fixing structural problems afflicting their economic systems.

The mutualization of debt is a sensitive issue to many, and Italian citizens should think twice before painting themselves as outraged victims of the EU. Southern countries generally suffer from rampant corruption, waste of public money and high rates of tax evasion. Proving to the rest of the European family that they are committed to fixing these problems would be an excellent step in the right direction.

Furthermore, from a strictly economic point of view, the refusal to set up Eurobonds is not as tragic as it seems. The European Central Bank is already supporting the hardest-hit countries with its Pandemic Emergency Purchase Programme (PEPP), which led to a fall in borrowing costs for Italy and therefore more financial levy to support its economy. The ECB also decided to accept junk-rated Greek government bonds to support the country during this emergency.

2 – Prejudices and irresponsible media are weakening our Union

The new coronavirus is a symmetric shock with asymmetric consequences which Spain and Italy did not bring onto themselves. The Dutch Minister Hoekstra was forced to apologize after his inexcusable remarks about Southern Eurogroup countries’ ability to face the looming economic crisis. In dire times of great suffering, such declarations from government officials, even if legitimate, feed mutual distrust between citizens of different Member States.

Many in the North of Europe see Italy as a bottomless pit which thrives out of European funds, forgetting the country’s role as founder and third net contributor of the EU budget and thus its fundamental role in the very financial sustainability of the EU. While problems are certainly present, stereotypes should never dominate public debates, especially in such delicate times.

The media have a great responsibility in conveying information from Bruxelles to European citizens. The weak public relations skills of the EU together with the language differences within the bloc, make national media the main harbingers of information to each country’s public opinion. The current international support to Italy is a topical case example: while the EU and its Member States have factually given and promised to Italy more support to face the epidemic than any other foreign power, many Italians still believe that China and Russia did more than the EU or that the EU did not support Italy at all.

Some might argue that this is the price to pay for the shameful refusal of Germany and France to send face masks to Italy at the onset of the emergency. However, few Italians know that the masks eventually reached the country thanks to the intervention of the European Commission. The media did not communicate such news as strongly and convincingly as they did with the negative news. Actually, they did not communicate it at all.

3 – A European Federation is still urgently needed

The federal government of the United States can adopt fiscal transfers to help poorer states recover from asymmetric economic shocks – rich states like New York or California sustain the finances of Arkansas and Mississippi in unfortunate times. After Germany’s unification, the federal government of Germany imposed a solidarity tax on the country’s rich western regions to foster the growth of its eastern territories, once controlled by the German Democratic Republic. Such measures are obviously unpopular within the richest regions, but it is difficult to find independent countries where some form of fiscal transfer from industrialized to poor regions is not in place. This also indirectly benefits richer regions, which find new customers and reinvigorated markets for their products and services.

European Member States are surviving in a multipolar world order where competing with emerging superpowers like China has become extremely difficult, also in military terms. The European Union represents the ideal platform to confront these powers as a unified bloc. However, the uncompleted integration process is revealing all its costly shortcomings. The EU can hardly be considered an independent foreign policy actor and its budget is completely inappropriate to face issues such as climate change and even pandemics in a coherent way. Yes, countries are also responding individually with their own resources, but this approach could also end up exacerbating existing disparities.

If some Member States are left with insufficient financial help, they could turn to China in search of more favourable credit lines. The signature of Memorandums of Understanding over the Chinese Belt and Road Initiative gives us a glimpse of what a more fragmented and less cohesive Europe could entail. China is known to use debt-trap diplomacy: this would risk leaving to the Asian power the control of key European assets and infrastructures.

While maybe politically unfeasible right now, the set up of Eurobonds must still be pursued to finally pave the way for a fiscal union and eventually a political union. When Eurogroup Member States realized that a Greek default would cause a grave rupture in the entire Eurozone, they set up the European Stability Mechanism because EU treaties did not allow direct fiscal transfers to the needy regions of the Union. It is time to rethink that mechanism. Leaders should, however, take into account democratic accountability in the process, in the hope that European citizens will come to realize that in unity lies strength.

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The Effects Of And Strategies Against The New Coronavirus

The medical aspect of this fight is best left to sources that can make qualified statements. But the dangers of coronavirus are clear: it’s a very contagious disease that is mild in most cases, but extremely threatening to the elderly and people with pre-existing conditions. Besides the lopsided mortality rates, which increase significantly with age, the new coronavirus also causes a very high number of hospitalisations, usually due to severe pneumonia. These hospitalisations greatly exceed what any healthcare system on Earth can handle at any given time – in terms of ICU beds, ventilators, doctors required to staff the units etc. Once hospitals collapse, the mortality rate skyrockets – both because coronavirus patients who could be saved in an ICU are left without medical care, and because people getting injured or sick from other ailments would have no access to medical help. Ultimately, the “do nothing” and “mitigation” strategies would result in millions of people dying. Should you wish to dig into the data, we can warmly recommend this fantastic piece by Tomas Pueio.

This only leaves one workable strategy: suppression. That is to say, extreme social distancing to deprive coronavirus of the opportunity to spread quickly, ideally bringing the number of sick people at any given time below ICU bed capacity. While of a more uncertain impact, this could also place selective pressure on the virus to favour less lethal and less noticeable strains. In order to work, however, suppression requires participation from the whole of society, as well as extensive economic mobilisation. The fight against coronavirus will not be won by doctors alone – the entire world will have to mobilise in order to sustain them.

We are at war. This is not just a metaphor: suppressing a pandemic is functionally very similar to fighting a war. Just like in wartime, there is a physical space of concentrated effort – in this case, hospitals, where loss of life is the norm. Just like during a war, sustaining this physical effort requires a complex logistical supply chain that includes coordinated production and distribution of essential equipment, like ventilators and face masks. The civilian population is also asked to make sacrifices – in this case, by staying indoors and following government directives. There is one major difference between a war and a pandemic, however. During a war, industrial production is maximised. The opposite happens during a pandemic, because the lockdown inevitably results in lower output.

The European Union has introduced a sweeping set of countermeasures – which are a good start, but only a start. As we look into what has already been done, remember that this is just the beginning of a drawn out effort that can only work if we act together. Suppressing coronavirus will change the European Union (and likely the world) in ways we cannot fully anticipate, and the pandemic is expected to trigger the worst economic recession since 1945, further increasing the complexity and fluidity of the situation. This is a world-upending, historical moment of rare magnitude, and we must all rise up to the challenge. Make no mistake: this will be a very long fight – but it’s one we can win together.

What The EU Has Already Done Against Coronavirus

The EU has a checkered record when it comes to dealing with crises. This is a product of its institutional set up and small mandate: the EU is built as a leadership avoidance scheme, which gives every Member State the breathing ground they need to come to bargains with one another, and have confidence that such bargains will be respected. This is great for wider European integration, but terrible in times of crisis, where clear leadership, fast decision-making, and an unequivocal chain of command are essential to response coordination.

However, the EU has learnt its lesson since its abysmal handling of the Euro debt crisis in 2012, where only the help of the Federal Reserve kept the Eurozone away from the abyss, as we detailed here. The measures being undertaken today at a European level are the right ones, and compatible with the small mandate of the Commission, they also display a refreshing dynamism.

First, the EU set up a Corona Response Investment Initiative, freeing up €25 billion that will shore up national healthcare systems, and shield workers and companies from the economic fallout of the suppression measures. It also allocated funds to vaccine research, as well as research of treatments that might make the pandemic more manageable. Additionally, the Commission has triggered the Stability Pact’s General Escape Clause, and greatly relaxed State aid rules. This will allow Member States to pump as much money into the economy as needed in order to fight coronavirus, bail out companies, and shield workers from the economic fallout.

These financial measures are paired with logistical and industrial interventions: the European Commission is coordinating, and massively ramping up, joint industrial production of all essential medical equipment, like face masks and ventilators. It has also forbidden exporting these products to third countries – with the exception of the United Kingdom, which is great news for London, since Britain only possesses 5,000 ventilators and lacks the domestic capacity to build more. Brussels is also setting up a common stockpile of all this essential equipment, to hand out to Member States to make sure that no one runs out. Once treatment and a vaccine are available, these will also be made a part of this common stockpile.

Further, the EU is also moving to ensure that the 300,000 EU nationals currently stuck outside the EU can make it back home safely, by pressuring other countries into keeping a select few airports open for emergency return flights, and ensuring the smooth functioning of the internet at a time of surging traffic through deals with Netflix, YouTube, and others.

However, the real centerpiece of the wider European effort to fight the new coronavirus comes from the ECB. It’s the so called “bazooka”.

Deploying The Bazooka

Following an embarrassing gaffe by Christine Lagarde, and after the global nature of the threat became evident, the European Central Bank introduced the so-called Pandemic Emergency Purchase Programme, also known as PEPP or, informally, the bazooka. This is the single largest measure so far at a European level. It’s an emergency €750 billion package to buy government and  company debt across the Eurozone. What this means in practice is that the ECB will guarantee Member States’ liquidity, so that whatever amount of money they spend to fight coronavirus will be backed up by the might of the ECB. The extension to private debt also means the ECB will be playing a hands-on role in protecting companies and ordinary people from the inevitable economic recession that will result from suppression measures.

There is no time-frame from when this will end, except that it will in any case last to the end of 2020 at a minimum. The timing of the maneuver is up to the ECB’s judgement. Ultimately, the pace of the fight against the pandemic, as well as the stimulus required to kickstart the economy after the outbreak , will determine how long this massive purchase of assets will go on. One thing is certain – this is a watershed in the history of the European Central Bank. Not even Draghi’s famous “whatever it takes” statement extended this far. In all the doom and gloom about the slow progress of European integration, we must also acknowledge that the progress done since 2012 is clearly on show here. This level of interventionism places the ECB much closer to a traditional central bank. There is free talk now of the PEPP helping guarantee jobs and companies as well as currency stability, after all. This may not have formally expanded the the Bank’s mandate, but in practice, it already has.

The Central Banks To The Front

This is a global pandemic, and as such it naturally warrants a global response. We have already witnessed a number of efforts at international cooperation against the new coronavirus, with varying degrees of success. For example, countries are trading doctors and task forces, ventilators and face masks, and the global scientific community is focusing on vaccine research. But what about financial and economic mobilisation?

Here, too, the EU does not operate in a vacuum. The ECB’s bazooka, in particular, is not an isolated measure: it is part of a wider effort by several central banks to guarantee that the global economy will survive the pandemic, and keep the machine of health and research running. The US Federal Reserve, the ECB, and the central banks of Japan, the United Kingdom, Switzerland, and Canada, are coordinating financial action in this respect. The reader might ask, why these central banks in particular, and what it is they are doing exactly. The answer lies in the lessons learnt during the Great Recession of 2008, and the Eurozone debt crisis of 2012. In that occasion, the Federal Reserve provided liquidity to other central banks – and in the latter case, particularly the ECB. These are currency swap lines, so called because the liquidity is denominated in multiple currencies. In effect, the Federal Reserve acted as the lender of last resort for other central banks. This was part of a “backroom deal”, and not widely publicised – American public opinion was vehemently against it, pushing the Obama administration to operate discreetly.

Today, these currency swap lines have been expanded. The same central banks that tried them out in 2008 and 2012 are now leaning on them even more strongly. What consequences this will have on world finance in the long term is hard to foresee, but in the immediate, the strategy is clearer: these measures prevented a heart attack of the world economy both in 2008 and 2012. The hope is that they will do so again.

European Coronabonds

Talk of coronabonds has also greatly intensified over the past week, with Commissioner Gentiloni quite open that the proposal is on the table. Fiscally conservative countries like the Netherlands and Germany have opposed any sort of financial risk-sharing at a EU level for years. They remained so even at the height of the Euro debt crisis in 2012, with Merkel famously saying that risk-sharing would not happen in the EU “for as long as I live”. This opposition to joint bonds has not dissipated, but the reality of the pandemic has significantly weakened it. Merkel is allegedly open to the idea of coronabonds. The Netherlands are still looking for an alternative solution they could table. However the rapid evolution of the pandemic makes the adoption of coronabonds increasingly likely. Italy and Spain are the hardest-hit countries, but almost every Member State is weeks behind them in the curve of contagions. As such, things will get worse at a European level before they get better.

Total War Against The Coronavirus

As should be apparent from everything we have outlined thus far, these are extraordinary measures that might have appeared radical only a short time ago. Now, they have become widely accepted – to varying degrees – as the correct measures to fight the global pandemic. But what happens after the world emerges victorious from the pandemic – however long that might take?

They will likely roll back some of these measures, though perhaps not all the way. Others will remain in place. Every major crisis in the past century or so has resulted in fundamental changes at an institutional and policy level. It was the Great War that first introduced the managerial State we are familiar with in the 21st Century, introducing a level of government intervention in the economy that would have been unthinkable before 1914. The Great Depression fundamentally reshaped the way statesmen thought about world trade, and the Second World War provided the shock that ushered in the contemporary global order. The Great Recession of 2008 has defined early 21st Century political culture, from the rise of the far right to the quasi-institutionalisation of currency swap lines between central banks. It is hard to see how a global pandemic of this magnitude could fail to do the same. It’s a historic moment that will lead to a profoundly changed conception of European institutions and their mandate. For better or for worse, we do not yet know. What we do know is this: there’s no going back.

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The most widely discussed remedies to the EU’s economic stagnation, especially by Anglo-Saxon economists, are low interest rates and fiscal stimulus. Low interest rates, with a brief hiatus in the period 2010 to 2012, have been tried. Many rates are now below zero, rewarding borrowers who take out loans with smaller amounts to reimburse. Still, borrowing money has risks if it is not used in manners which increase its value. It would appear that, after several years of low rates, European businesses have run out of new projects with positive returns and borrowing, and consequent increases in economic activity have once again slowed.

Recognizing this, economists have turned to fiscal stimulus as the remedy of choice. Fiscal stimulus, the excess of government spending over revenues, will give a short term boost to economic activity. The aim is to generate a virtuous cycle where those newly employed by the stimulus will generate further economic activity through their spending and additional tax contributions. The problem here is the same as that of low interest rates. The new activities generated must be self-sustaining, in the sense that they increase productivity and revenues. If they are not, they will simply create additional debt burden and cause the economy to slow once the additional stimulus is passed through.

Constraints to Productivity Growth

There are some natural constraints to productivity growth in the EU region which must be addressed before the remedies to slow economic growth bear fruit. A shortage of natural resources and energy dictates that the continent can not generate growth without increasing imports of raw materials and energy. But to import what it needs without further indebting itself to foreigners, Europe must increase its exports to pay for the additional imports. It must, therefore, remain competitive in markets and look to expand those markets if it wishes to sustain its own growth.

This is not totally within Europe’s control and, consequently, the ability to export successfully is an upward constraint on Europe’s domestic growth. Economists who talk about lowering interest rates or fiscal stimulus without taking into account the reliance on world markets are simply missing the point. When world markets are growing Europe will have no difficulty sustaining its own growth. When they are moribund effective stimulus will be well nigh impossible.

The Way Around the Growth Impasse

Trade agreements for regions like the European one are essential to maintain regular access to markets and obtain needed commodities. However, they cannot resolve this impasse on their own, as they can’t guarantee competitiveness or the vitality of foreign economies. There is only one sustainable solution to further economic growth in the long term: to invest in research, sustainable energy, food production and more efficient use of raw materials.

Besides helping the planet, such research will allow Europe to grow at its own chosen pace without imports. Once growth can be generated internally without requiring an increase in essential imports, techniques like interest rate policy and fiscal stimulus can be used to full effect. There is no magic wand of economic policy for sustainable growth if the right productive investments are not being made.

Rallying Around The European Project

An important aspect of any economic policy is public assent. Successful policies – most often defined, unfortunately, in today’s short-term mindset – entail some sort of job creation, wealth effect and a general feeling of well being and optimism for the future. A successful policy in these terms usually brings assent in its aftermath regardless of its long term vision or sustainability.

Getting the public to agree to a policy based on a vision of the future, one which requires sacrifices, investment and research with little immediate impact is difficult in democratic societies. To some degree, this is understandable as a job is a necessity today, not once the research and investment bear its fruits. For this reason, despite some misgivings, a stimulus project on a European scale might also be appropriate, especially if a productive policy is not chosen.

The building of a new European capital with the participation of all the Member States is a project which can rally the public to the EU idea and provide an immediate stimulus to jobs and incomes. It has the disadvantages of other stimulus projects in leading to a deterioration in the balance of payments but since such a project would be labour-intensive, these effects should not be too large. Investment in a new capital also brings with it some small efficiencies which can help pay for it while awaiting the fruits of investment in energy, raw material and agricultural research. The hoped-for rallying around a vision of Europe can not be discounted only in financial terms.

Alternative EU-wide stimulus projects can be envisaged. Building on the success of the Airbus Industries, space exploration could be expanded beyond that now undertaken by ESA. Future space colonies could be prepared and undertaken. However, I prefer to be more down to earth myself and a greatly enhanced effort in space would have one important disadvantage: it would employ few people per euro invested.

More and faster high-speed rail, especially given the environmental concerns associated with flight, is another possibility. Regreening and reforesting Europe is another stimulus project which the unemployed and school-aged alike could participate in.

A Vision For The Future

Endless economic growth is not always a goal worth pursuing. With growth comes environmental degradation, overcrowding, loss of natural habitats and other undesirable consequences. Some growth at a minimum is probably desireable to absorb the pool of unemployed and to facilitate the adoption of and transition to new more efficient technologies as they emerge.

Europe may well wish to forego rapid economic and demographic growth and the ensuing economic competition with the United States and China, in preference for a more sustainable and greener continent. Europe is already a crowded continent with a population of 103 people per square kilometre, compared to 36 in the USA. Only India (416), Indonesia (149) and China (145), among large countries, are more crowded. Vast regions of the world: Australia (3), Canada (4), Russia(8), Brazil (35), and many areas of Africa, are much less densely populated.

A choice of sustainable greener growth will require new social, economic and legal tools to realize it. True federalism would certainly facilitate the complex social, economic, and political choices as well as their implementation. So hopefully would a new federal capital. Whatever its vision of the future, however, Europe will need greater energy, food and raw material self-sufficiency to realize it.

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Veto, Deposits and the Single Market

One apparent issue with the Union, in its current form, is the veto power itself. Even bearing in mind that it is rarely used and that it is an option only for certain types of votes, it still can be an issue. It prevents any EU foreign policy from being applied consistently and would be a huge impediment to the working of a common defense force. Sovereign states cherish it though, particularly in the case of enlargement, war and peace, or other vital matters.

Among other reforms frequently mentioned, there is the financial sector. A deposit guarantee scheme is one important idea. The scheme would be meant to encourage savings, and provide protection to weaker financial institutions, as well as the public. Aligned to the financial sector, another essential reform would be the further development of the single market, especially for services. It is one of three priorities of the new President of the European Commission, Ursula von der Leyen outlined in her introduction of the new Commissioner Vladis Dombrovskis of Latvia:

“We have a unique social market economy. It is the source of our prosperity and social fairness. This is all the more important when we face a twin transition: climate and digital. Valdis Dombrovskis will lead our work to bring together the social and the market in our economy.”

Recently Macron and Merkel informally put forward the idea for a two-year Conference on the Future of Europe. Although it is not clear what the main focus of the conference would be, it could still be a good place to answer questions about these reforms, particularly about fast tracked reforms, something that it is perhaps reserved for countries willing to further federalize.

What is the European Single Market?

You can think of the European single market through your own experience of working and consuming as an EU citizen. We have largely achieved the single market for goods, but price convergence has lagged. You can buy pretty much the same goods throughout the Union though at different prices – and states do occasionally create impediments, usually to benefit their producers.

The single market for services remains largely incomplete. As a doctor, lawyer, engineer, pharmacist, accountant, architect, or even real-estate agent or taxi driver, you can be subject to differing regulations and unable to use your license or skills in another EU country. Schengen may have made it possible for EU citizens to move freely, but not necessarily work freely.

A series of EU Directives and landmark rulings of the European Court of Justice (ECJ) have called for mutual recognition of regulatory restraints on providing services except as necessary to satisfy “mandatory requirements relating in particular to the effectiveness of fiscal supervision, the protection of public health, the fairness of commercial transactions and the defense of the consumer”. In practice though, mutual recognition has been far from fully implemented and the obstacles have not all been removed. Often, re-assessment of market authorisations are required in EU countries for the provision of services, even in cases where it should not technically be possible to derogate from the rule of mutual recognition.

Although less common, a similar situation can arise with harmonised standards for goods, where local state enforcement can sometimes be used to circumvent EU regulations. The only way to prevent such problems may be true federalism where the EU can enforce its own regulations. Until then, states will have a tendency to make things difficult for non-national individuals or products. A survey of EU services  firms cited regulatory restrictions as the primary impediment to expanding their operations in other EU countries. For this reason fast-tracked reforms for member states willing to federalize might prove fundamental in advancing the single market for services.

What are the Advantages of the Single Market?

As an European citizen you may have traveled by train throughout Europe, visiting the beautiful continent. You will have sung goodbye’s at train stations to your friends, chanting “Bella Ciao”. You will not have needed a passport or a visa, and after 1999 you haven’t needed to exchange your money to local currency, in most cases. Though certain rail lines in Eastern Europe and the Balkans may have required changing trains at the border, rail harmonization too is a product of the single market.

Beyond free movement and the Euro, the single market has radically changed European life in other ways. In the 1970s you would have done your grocery shopping in local stores while walking home from work, or in your own neighborhood after driving home or using mass transit. Small local shops were the main source, and in many cases the only source, of retail trade. They were often family-run, open long hours, and economically very inefficient, requiring as they did frequent dedicated deliveries of small quantities of goods. One of the major effects of the single market was to rationalise retail trade on much of the continent.

With the single market, supermarkets and hypermarkets began to appear on the outskirts of cities and large towns, forcing the small shops to close and often leaving the city centers empty and boarded up. They brought goods to consumers in huge variety and at much lower prices, extended the season for fresh purchases with imported produce, and offered a variety of tropical and exotic products. They could afford to do this because their cost of capital was lower, purchasing and deliveries could be done in bulk, and labor needs per unit of sales were considerably lower.

The economic upsides of the rationalisation of the retail sector go beyond the immediate benefits experienced by consumers. Smaller shops by closing down free up labour for other economic activities, contributing to economic growth. Capital is also freed up per unit of production, as the distribution networks become more efficient.

Further Rationalisation of the Services Sector

If we achieve further rationalisation of the service sector in Europe, young professionals wishing to work abroad stand to benefit the most. If you are looking for a change, enhance your language and professional skills, or have a foreign partner, you will no longer be hindered by complex licensing requirements. The costs of services would also decline. The economic benefits of this would be great. But so would the downsides. Rationalisation of the service sector could easily bring a new period of economic growth. But growth also means disruption.

Ultimately, Europe has two options: remain a more traditional economy, with strong worker protections and a minimum of change and disruption; or compete fully in the global economy by rationalising, reaping all the benefits and paying all the costs. Finding a middle way will be very difficult, especially considering the pressure from China and the US, which have already made a clear choice: efficiency and competition at whatever the social costs.

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China’s reawakening might not have been as abrupt and disruptive as Smaug’s, but it has certainly contributed to the narrative shift we are witnessing today: the centre of economic gravity will soon lie elsewhere, in what a 16th-century explorer from the West would have naively called “the rest”. EU’s share of the world GDP (PPPs) will almost halve by 2050 and the European powers are destined to lose their position as top global economies (Pwc 2017); major Chinese cities can already boast GDPs comparable to those of entire European countries, while the Old Continent is set to become a demographic pigmy according to most scenarios (European Environment Agency 2016).

“Hide Your Strength, Bide Your Time”

The Dengist maxim “hide your strength, bide your time” was officially discarded in 2017, when China’s Paramount Leader Xi Jinping announced China’s grand entrance into the global geopolitical arena. Such participation had already begun when its markets silently opened to foreign investments, and the government promoted outward-looking policies such as Go Global/Go Out and Peaceful Rise. However, this new assertiveness has taken a bigger, forward-looking tone with the One Belt and One Road Initiative (OBOR) inaugurated in 2013.

The OBOR is more of a long-term vision than a clear project. The strategy entails a multitude of investments in infrastructures such as railways, pipelines, industrial parks, ports and highways along two main routes: the Silk Road Economic Belt and the 21st century Maritime Silk Road. OBOR involves more than 65 countries, the majority of which are in the Eurasian continent. Indeed, the Chinese government aims to develop the country’s western provinces further by bringing back the central role that the ancient Silk Road played in transcontinental commerce between Europe and the Far East; moreover, unstable countries in Central Asia and poor infrastructures along the maritime route to Europe curtail the potential economic gains that well-connected and economically prosperous countries could offer.

An Economic Uproar

The recent choice by the Italian government to sign a Memorandum of Understanding (MoU) concerning the Belt and Road Initiative (BRI) has shaken the West, with the EU’s budget Commissioner Oettinger even suggesting to confer the EU veto power over matters of such importance. The uproar comes amid parallel fears in different contexts, such as spying accusations involving the Chinese technology giant Huawei and disagreements at the WTO level, where China is constantly criticized for unfair practices like price dumping.

Researchers agree that Belt and Road could lead to great economic benefits, especially for those landlocked countries in Central and Eastern Europe (CEE) and the heavily indebted Southern member states. Overall, trade in the EU could increase by 6% (Garcia & Xu 2017). Moreover, the importance of the Mediterranean ports has steadily increased in the last years, with most of the traffic from the Suez Canal favouring them over the northern ports of Rotterdam and Hamburg (Prodi & Fardella 2017); Italy aims therefore to enhance the role of its ports (Genova, Venice and Trieste especially) as the fourth European economic power trails behind France, UK and Germany in imports and exports to and from China, and also lags behind in terms of investments and capital circulation.

The Belt and Road Initiative Between Wealth, Power and Politics

Despite assurances from President Xi Jinping that the strategy would only lead to economic prosperity, the EU is right to approach Belt and Road with caution: Chinese state-owned giants are privileged actors in this endeavour and their interests might not always overlap with the EU’s; transparency and project sustainability are also important issues that China has not sufficiently dealt with until now. Economic theory teaches us that trade and interdependence favour the well-being of consumers and create bonds that help prevent unwanted events such as wars. With wealth, nevertheless, power and politics come into the equation.

The EU is clearly divided on the issue: last week the French President Emmanuel Macron welcomed Xi Jinping together with Angela Merkel and EU’s Commission President Jean-Claude Juncker, seemingly signalling that a multilateral EU-wide framework is needed to gain the most benefits out of this challenge (or opportunity). Italy’s embrace of the BRI, the first G7 country to do so, could therefore push European member states to seek more unity, after the adherence to the MoU by other 11 member states (Croatia, Czech Republic, Hungary, Greece, Latvia, Luxembourg, Malta, Poland, Portugal, Romania and Slovakia) failed to attract the attention needed. Not coincidently, on March 12 the Commission issued a meaningful press release referring to China as both a negotiating partner and a “systemic rival promoting alternative models of governance”. It is quite a symbolic defeat to witness a systemic rival, embodied by the state-owned giant COSCO Shipping, owning 51% stakes in the Port Authority of Piraeus in Athens, the cradle of European democracy.

But it’s not too late. MoUs are non-binding cooperation frameworks and the agreements signed between Italy and China during Xi’s visit to Europe have limited economic impact and do not confer Chinese companies the ownership of vital infrastructures; more specifically, the arrangement concerning the ports of Genova and Trieste and the corporation China Communications Construction Company (CCCC) does not contemplate the acquisition of the ports’ authorities but rather aims to enhance connectivity to railway infrastructures. There is still time for the EU to find a more coherent approach and to take a leading role in the initiative: the EU represents the ending destination of all trade routes and has therefore leverage and say over the agreements taking place within its borders.

Intra-European competition, however, represents a major restraint to the stronger coordination needed at the EU level. Ports in the Northern Range (Antwerp, Rotterdam, Hamburg) also benefited from Chinese capital; the hostility coming from Northern member states over the cooperation agreements signed between the Chinese companies and the Italian ports might, therefore, be driven by fears that the economic significance of such ports would be downsized. Indeed, Professor Bart Kuipers, an expert on port economics from the University of Rotterdam, argues that the planned railway connections in Southern and Central Europe would reduce the container traffic in the Northern range ports by 1,6%. New interconnection projects could even increase such percentage.

COSCO Shipping has a 35% stake in the new generation terminal Etr Euromax Terminal Rotterdam, and 20% in the Antwerp Gateway terminal, while a Chinese consortium led by CCCC (which also includes Ali Baba founder Jack Ma) has been awarded the contract for the construction of a new automated terminal in the port of Hamburg in 2017. The competition also arises within the Mediterranean, where ports in the Adriatic seek to supplant the centrality of the Piraeus.

The EU’s timid response to this reality does not offer an effective solution to China’s “divide et impera” strategy. Xi Jinping has been engaging with CEE countries through the “16+1 platform”, a transnational initiative which further endangers the cohesion of the EU on the matter.

A Commission Proposal Approval From the EU

After insistence from France, Germany and the previous Italian government, the European Parliament approved a Commission proposal contemplating a screening mechanism for Foreign Direct Investments (FDIs), already existing in the world’s major economies. The vote, which took place last month, saw an overwhelming majority (500 in favour, 49 against). While “critical sectors” to protect, such as aerospace, media and health, have grown in number thanks to MEPs, Member States will still have the final say over such investments.

Supranational institutions such as the Commission and the European Parliament have the potential to counter member states’ egoism and safeguard the Union’s common interest. However, the economic crisis has left economically weaker Member States in need of financial resources and are therefore more inclined to entertain bilateral relationships with foreign investors and oppose intrusion from the EU. Manfred Weber, formerly the European People’s Party’s Spitzenkandidat for the presidency of the European Commission, has spoken in favour of a measure that would allow the EU to decide on a case-to-case basis whether foreign investment is detrimental to the EU’s interests.

A Much Bigger Phenomenon

The role of the Belt and Road Initiative in Europe is only one component of a much bigger phenomenon:  the transformation of the world order as we know it. Regionalization has brought the emergence of power blocs and their respective spheres of influence without the need of a Cold War in the background; China’s rise is particularly worrying for the hegemonic United States, which fear that a Thucydides trap could be waiting at the next corner. Chinese claims over Taiwan, its unprecedented activism in Africa and assertiveness in the South China Sea, which threatens the international maritime law, also contribute to the cautious and often confrontational approach taken by Western powers over the OBOR.

The signature of the Memorandum of Understanding by a G7 economy might have offered an important boost towards a more harmonised line of action without having created irremediable rifts in the West and sold fundamental assets to a foreign power; moreover, the long-term essence of the Belt and Road Initiative and the usually short life-span of Italian governments might play in favour of those who are showing scepticism over the Chinese strategy, with an unexpected change in direction from the next Italian government.

The rationale behind this signature appears less surprising when Italy’s intra-government dynamics are taken into account: the two parties in power are divided on the issue; the Five Star Movement is championing closer relations with China in the likely intent to gain more leverage over Brussels with regards to budget flexibility. The North League opposed the signature, but it might have given up its opposition in a show of gratitude to the 5SM, whose votes in Parliament were crucial to forestall a trial on Matteo Salvini over the seizure of an NGO ship.

The Economic Relevance of the EU

Nevertheless, we should not let paranoia poison the debate. The stability of Central Asia is also in the interest of the European Union and so is the rebuilding of the hard-hit economies in Southern Europe. The Belt and Road Initiative presents an opportunity for both economic development and reform of domestic governance in the EU, provided that sensitive assets remain in control of European democracies. The issuing of the EU-Asia Connectivity Strategy last year may be the indication that the EU is ready to curb Chinese soft power in Asia, but the difference in terms of resources available and strategic capability does not play in favour of the Old Continent. Indeed, a more coherent structure, a bigger budget and more effective decision-making are needed for the EU to avoid losing economic relevance in the next decades.

More than ever, the EU’s policymakers should ask themselves whether it is time to step up the game and advance European integration or remain in the limbo where the European Union is currently stuck. Uncoordinated responses, diverging policies and overlapping initiatives do nothing but offer foreign powers the possibility to have the high ground in negotiations and extract concessions more easily. The Union has already shown its potential in matters of trade, where it has managed to carve out an important role as market power, and even in foreign policy, although exceptionally and with mixed results. However, with a budget representing only 1% of the EU’s GDP, the Union is unlikely to keep up with competing for power blocs in general investments and many of the relevant fields of the near future, such as artificial intelligence and space exploration/exploitation.  Of course, a long-term economic strategy such as the Belt and Road Initiative might not be the only factor. Donald Trump’s repeated criticism over Europe’s commitment to NATO, Russian rearmament, climate change migration flows can also change in the mindset of policymakers, both in Member States and EU institutions.

Bibliography

An earlier version of this article was originally written for the University of Leiden. 

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The revamped trade deal with Mexico, and the titanic agreement with the South American trading bloc Mercosur, are also part of this success story, but it’s significant to note the effort the EU is putting into developing ties with the Far East. It was only two years ago that the EU lamented the lack of a coherent policy for southeast Asia, with only a free trade agreement with South Korea already in place. Two years later, the EU has signed large-scale deals with Singapore, Vietnam, and Japan – with the latter deal already undergoing implementation. This undoubtedly strengthens the European position in the Far East.

The Terms of the Deal

For starters, the free trade agreement will eliminate 99% of the tariffs on both sides. ‘Sensible goods’, i.e. agricultural products, will be the exception, and will be limited by quotas. The volumes involved are important: currently, the EU is Vietnam’s second largest export market after the United States, accounting for around 19% of its total exports. The main Vietnamese products that make their way to Europe are textiles, electronics, and coffee. The EU also exports to Vietnam, mostly high tech products, pharmaceuticals, machinery, and aircraft. The volume of these exports is growing by 11% every year, and stood at €12 billion for 2018.

As usual, the agreement has provisions for the protection of food or drinks with a specific geographical origin. This protection includes both Vietnamese and European traditional products, like Mộc Châu tea or Calvados. It also contains provisions for public procurement. Under the framework of the agreement, companies will be able bid for public procurement contracts and access the services market both in Vietnam and in the EU. At the same time, the free trade agreement will not curtail the right of the two parties to decide how to organise their public services.

One the most important part of the FTA are the provisions for sustainable development: the FTA includes the implementation of the Conventions of the International Labour Organisation. These include the core standards on freedom of association, and prevention of child labour and slavery. The agreement also requires the implementation of international environmental deals, such as the Paris Agreement. In a classic exercise of EU soft power, the issues of fighting climate change and strengthening democracy go hand in hand with the economics of the trade deal.

The Road Ahead

The agreement has been discussed for a long time. It began as a negotiation between the EU and ASEAN, in 2007, but in 2009 the two parties decided to switch to bilateral negotiations. Future trade deals between the EU and ASEAN will start from the existing agreements and expand their scope. The free trade agreement with Vietnam would be the first of these ambitious trade deals, to be followed by the deal with Singapore, giving the EU a stable trading foothold in Southeast Asia.

The implementation of the free trade agreement will begin after the two parties ratify the agreement. For the European Union, this means that the European Parliament will have to vote in favour of the deal. One obstacle, however, remains: Vietnam’s human rights track record. This was one of the biggest concerns during the seven years of negotiations, and with good reason: Vietnam is a one-party State, known for the harsh treatment of dissidents. Reporters Without Borders classified Vietnam as the 176th country out of 180 for freedom of press.
Cecilia Malmström sees the free trade agreement as a way to engage with, and influence Vietnam on human rights. While she is adamant that the deal alone cannot remedy the lack of human rights in Vietnam, she also believes that increased contact and exposure will soften many of Vietnam’s positions.

Indeed, the final version of the agreement contains clauses that enable the parties to take action, should the human rights obligations contained in the text be breached. These actions include the suspension of the trade agreement itself. The European Parliament will have to decide if these provisions are enough.

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The Latin countries’ bête noir of choice is the Germans. A distinct Latin criticism is that Germans are running the show to their advantage. Further north unnamed bankers fit the criticism bill. Everywhere the bureaucrats are to blame and for some conspiratorial souls the villains form a cabal centered in Bitburg of all places! Overly restrictive monetary policy in the EMU ‘austerity’, they exclaim, is or was keeping the Euro strong and real interest rates high.

This critique ignores the historically low, sometimes negative actual rates. Euro economies, they affirm as a result, are mired in slow growth and deflation protecting only the already well to do, creditors not debtors. “Austerity” is the cause of all of Europe’s problems. Simply said, a looser monetary policy, inflating Europe’s way out of economic stagnation, is the panacea, a cure-all that the Germans, fearful of Weimar type hyper-inflation, stubbornly refuse to consider.

There may be some truth to all this, “wisdom out of the mouths of babes,” but wisdom such as this does not stand up in the adult world. Even at the highest point of rhetorical criticism, financial markets remained unconcerned, putting about a zero probability on anyone leaving the EMU.

Since Brexit began, even leaving the Community and Customs Union appears to be fraught with hurdles, though the British may succeed in some form or other. Leaving the European Monetary Union is another matter altogether. Note we are not talking about bank failure or sovereign default as Greece almost experienced – that indeed would get one out of the EMU, even if the human agency is unlikely to.

Evaluating A Looser Monetary Policy

Let us deal with the arguments raised in favor of a looser monetary policy initially. We shall discuss these before showing that, however, good or erroneous these arguments may be, leaving the EMU would create problems all its own that would inevitably lead to economic collapse.

The first issue is with the erroneous assumption that the monetary policy of the European Central Bank has been consistently tight. Though the ECB’s initial response to the 2007-2008 economic crisis was to lower already low-interest rates only modestly, — they, unfortunately, were already quite low leaving them little room to lower further — the ECB later reversed this policy and accelerated stimulus in 2015 when the economy was seen to be recovering more slowly than hoped.

The ECB then began, in addition to interest rates, to use procedures known as quantitative easing, where the money is injected into the economy through the purchase of debt instruments. Though the economy did respond positively to the change in policy, growth was less than hoped for, still impeded by structural factors and world markets. It is not unreasonable though to think that the ECB acted wisely and that the measures favored by its critics would not have had the desired effects. To determine the appropriateness of ECB policies, we must look at the structure of the EU economy as does the Bank.

The European economy is highly dependent on imported energy with the unique exception of France. For the rest of the Union, large importers of energy, a strong euro purchases more energy per unit of currency than a weaker one. By keeping the Euro strong, the Central Bank kept all important energy import costs at lower levels than they would be with a weaker currency and more expansive monetary policy.

Secondly, the effect of expansionary monetary policy – lower interest rates, more money in circulation and a weaker euro – is according to the ECB’s critics supposed to stimulate the economy, and especially it is hoped the export sector, through a lower exchange rate.

In the real world, unfortunately, things are not so simple. The desired effect depends to a large extent on what one is exporting and how these exports are produced. Exports produced with a high degree of inputs from abroad like petroleum (energy), or other raw materials, may go up in price because the cost increase of these inputs offsets the decline in price resulting from the weaker currency.

After considering one’s production costs, the consideration of a customer’s reaction to the new prices must follow. One of Europe’s principal exports is luxury goods.  Dior, Louis Vuitton, Gucci, Mercedes, or Ferrari are sold to select groups of elite shoppers around the world. It is not at all certain how much this market would expand in response to a lower euro and hence better prices abroad. There are only so many very wealthy individuals buying Ferrari’s. A contrary effect where buyers might find the goods devalued from their luxury status through a price drop is even a distinct possibility.

For other products, there may be different constraints on the expansion of sales. Agricultural products are heavy energy users, a negative in a devaluation, but unlike luxury goods may respond well in the market place to lower prices inducing consumers to buy European or in some cases consume more. However, available land, on the other hand, can be a considerable constraint to increasing agricultural production, so even when demand responds favorably, producers may not be able to respond by increasing their production more than marginally.

When looking at the effects of a devalued currency, the ECB must take all these factors into account. It is not at all clear, especially because of Europe’s position as a net energy importer, that the effects of devaluing the Euro would be very beneficial. Another factor too often neglected is that with an ageing, static population that includes immigrants, growth is increasingly harder to come by.

Debts in Euro Will Not Go Away With A New Currency

But one thing is abundantly clear and has been so to markets: whether the critics prevail and monetary policy becomes more accommodative or German fear of inflation continues to pose a restraint, no one is leaving the EMU in order to have their way on these issues and assert a more independent monetary policy. The reason is actually simple.

Under the single currency debts throughout the eurozone are denominated in euros. If countries were to exit and set up new currencies: franc, lira, or peseta, for example, contractual debt would still exist as a holdover in euros and debtors would need to raise money in their new local currency and purchase euros in order to pay back the debt.

All this new buying of euros would cause the value of the Euro to rise against the local currency making it more and more costly to service one’s debt. In what would already be a weak economic environment, many firms would go bankrupt. National governments unable to pay back their debts would also have to declare bankruptcy. Banks would refuse to extend credit for trade. Economic chaos would surely ensue.

A Similar Problem in Poland and Hungary

Something similar happened in Poland and Hungary though on a much smaller scale. While not in the eurozone the two countries thought they could profit from international financial markets to make loans available to homeowners. To diminish their risks, international banks made the housing loans available only for a commitment to repay in euros or Swiss francs.

As few Polish or Hungarian borrowers had income in euros or francs, the weakness of the zloty and forint against these currencies caused repayment costs to go up significantly with numerous foreclosures ensuing. Though losing one’s house is bad enough, this pales to what would happen when leaving the EMU.

All homeowners who live in euro countries have their loans denominated in euros as well as all businesses, governments and other borrowers. A very few large businesses have some loans in dollars, but these will suffer in the same manner as Euro-denominated loans if these businesses have to earn their revenue in deflating currencies.

Italy Contemplates Euro Alternatives

Recently, the Italian Lega-led coalition government offered a resolution in the Italian Parliament to create special bonds. These bonds for repayment of Italian government debt would not be denominated in euros.  A new unit called ‘mini BOTS’, where BOTS are ‘buoni ordinari del tesoro’ or ordinary treasury bills, would be created. The BOTS would have a numerical value exchangeable for certain government services like railroad tickets or postal services.

As it stands now, the proposed mini BOTS would have no due date or carry interest like ordinary bonds. They would represent money issued in counterpart to government IOU’s to vendors but would have no fixed value in gold, euros or dollars and limited value in exchange for government services.

The resolution passed but is non-binding lacking implementing legislation, as is often the case with resolutions of this type in Italy. The financial markets did not hiccup as they often do when Italy threatens large budget deficits or other measures that could weaken her banks.

Why is this? Simply because nobody believes that the mini BOTS will be implemented and if they were, they would have no effect at all on possible Euro exit until perhaps twenty years from now. The reason for this is clear. The BOTS would have to establish some value for anyone to accept them in any large quantity to replace existing debt. They would need to be convertible to other more reliable currencies too.

A market for BOTS would then develop trading against the Euro, dollar and other currencies. As the value of the BOTS declined, as it most certainly would be bot: (1) an entirely new currency that few would immediately trust; and (2) backed only by Italian governments running large deficits and whose rhetoric at least has not been thought by many in the international community to be too responsible.

The same problem of paying back debts in a devaluing currency would occur, this time through the loss would be to the creditor or debt holder who would find their investment devalued. No old debt holder with euro debts would want to take them in exchange.

New debt holders might have no choice, but they would raise prices, refuse to sell to the government and push interest rates sky high – through lower prices for the instruments on the aftermarket, as the mini BOTS would initially carry no interest —  in order to compensate for the increased risks. BOTS taking on these characteristics of money would additionally violate EMU restrictions Italy agreed to, not to issue alternative currencies.

It would take ten to twenty years for new BOT debt to replace the old euro debt presuming there was any interest among long term debt holders which is very unlikely – at this point discussion is only for short term BOTS so longer debt presumably would still be issued in euros.

In that time, twenty years of economic decline will have been enough to wipe out many Italian governments and leave the euro standing. And remember all new private debt during this period would still be in euros, so the mass of euro debt would still be enormous and prevent the government from leaving.

There is one proposal to make the BOT’s denomination extremely small so that it would target small savers. Such short term, small denomination BOTS might avoid a parallel currency market altogether, as they would be too small to interest most traders.

But, whatever else this short term instrument would do it would not replace the Euro. The cost of administering such a program might also obviate any gain. Right-wing politicians and even a few who should know better may rant about EU hegemony, austerity and other ills. No one though, is leaving the Euro any time soon.

Guest article by Stephen Sposato. This content does not necessarily reflect the official opinion of My Country? Europe. Responsibility for the information and views expressed therein lies entirely with the author.

About the Author: Stephen Sposato is an American who received his Masters in Economic Development from the Rijksuniversiteit Gent and a second Masters in Theoretical Economics from the Universite de Louvain. He has lived an important part of his 72 years in Europe where he has also worked on East European reconstruction. He speaks a number of European languages fluently (English, French, Dutch and some German).

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This momentous transition presents different opportunities and challenges for the European automotive industry, which invested significant energy and capital into developing clean diesel combustion engines. This choice has backfired catastrophically, leaving the EU auto sector searching for a new way to remain competitive worldwide.

A Limited Transition

The quickening pace of transformation shouldn’t give the impression that the automotive industry is fully converting to electric mobility. In fact, the transition remains fairly limited. In 2017, registrations of electric vehicles (EV) represented a mere 2% of all new vehicle registrations in the EU. The number was only slightly higher in China (2.5%) and in the U.S.A. (3%). Unsurprisingly, given its size, Beijing has surged to the top in absolute numbers: in 2017, China was home to 48% of all registrations of electric vehicles worldwide, with the United States trailing a distant second at 16%, and the EU third at 15%.

The true ramifications of this disparity become apparent once we consider Dieselgate’s impact on the European automotive sector. Following the shocking revelations of the emissions scandal, diesel bans have been introduced in many European cities and regions. As a consequence, diesel registrations have fallen dramatically all over Europe. ‘Clean’ diesel has represented the crown jewel of the German automotive industry for years, and the wider European industry has invested heavily diesel as well. Now, one thing is apparent: European carmakers have bet on the wrong horse, and now they’re paying the price.

The World After Dieselgate

Dieselgate has dealt a devastating blow to the European automotive industry, crippling its credibility with the public and fully exposing the limitations of the technology in terms of carbon emissions. While the USA, Japan, and China moved into the lead on electrification, European carmakers sank money and effort into a technology that is increasingly out of step with the times.

The issuing of patents is a telling indicator of the resulting decline. In the early 2000s, EU producers accounted for over 70% of patents on internal combustion engines, and 50% of patents on electric power trains. In 2010, that number fell to just above 40% share of all patents regarding all power train technologies (electric, hybrid, hydrogen, internal combustion). The European automotive industry still remains dominant in the field of internal combustion cars, but finds itself lagging behind on electrification.

The ambivalence of electrification – a threat and an opportunity at the same time – is reflected in industry attitudes. While European carmakers are eager to embrace and promote a “green” image, sceptical comments still get their time in the sun. Recently, Italian industry moghul Alberto Bombassei warned Italian consumers against electric vehicles, arguing that the EU should take a stance in defending its traditional automotive industry. Even though Bombassei’s protectionist and neo-luddite arguments might sound outdated and counterproductive, what makes his statement appealing to the general public is that it promises to safeguard jobs.

The switch towards electric, or electric hybrid plug-in vehicles, does imply far-reaching changes to the labour market. Electrification would lead to reduced demand for mechanical engineers, while demand for electronic engineers and IT experts would grow. Similarly, the supply chain would undergo its own dramatic transformation, with workers needing to specialise more and more on electricity, circuits, and IT. Additionally, the manufacturing of electric vehicles requires fewer workers compared to traditional internal combustion vehicles, but the complexity of the product might open the door to more jobs in customer assistance. It is likely that these shifts will lead to intensified lobbying for and against electric cars in the future.

Playing Catch Up On Electrification

The EU, a world leader in different areas of the automotive industry, now finds itself chasing the pack on electrification. The cars themselves show signs of promise, with the new models proving popular with customers. The European industry, however still crucially lags behind in battery production, and it’s Chinese brands that dominate in the field of battery patenting and manufacturing. Batteries are currently the most expensive component of electric vehicles, and in effect this means that China enjoys a de facto monopoly in what is currently the most expensive segment of the electric transportation supply chain. Only recently has Daimler started challenging this position, by investing nearly twenty-three billion Euros in developing new battery cells.

Stimulating demand might give the EU auto industry the jump start it requires to make up for lost time, but an even better option would be stimulating supply. The industry needs to invest approximately fifty billion annually to claw back the current gap. European battery-makers are feverishly at work to increase production and meet Europe’s growing demand for batteries, but it will take years before their efforts come to fruition. Public R&D support could help develop the next generation of clean technologies (e.g. solid-state batteries), and conversion from pre-existing technologies could also be encouraged in a similar fashion. Brussels-based think tank Bruegel has recently proposed the creation of an “EU Clean Transport Fund”. This would provide funding to countries and cities willing to deploy the infrastructure required for electrification. A non-exhaustive list includes urban planning, public transport, and charging stations.

Additionally, the global dimension of electrification means that free trade and trade deals can bring considerable benefit to the electric transition. Even though Chinese, U.S. and European car industries are in competition, together they can service a formidable market of nearly two and a half billion customers. As the respective industries grow and interact, a new global supply chain is developing around them. Lowering supply costs and other similar factors have the potential to dramatically boost electrification all around the globe.

Electrification represents a true game-changer for the automotive industry, and brings with it the prospect of dramatic changes to the labour market, to global supply chain, and technological development. Much like at the dawn of the history of the automotive industry, in the late 19^th century, the early models of electric cars are extremely expensive (with the cheapest models currently costing like a mid-high range combustion-powered car), and the designs still need time to reach maturity, and break out into the mass market.

The EU automotive industry entered the race late, in no small part due to its ill-advised investment in diesel technology, but it’s not too late for it to assert itself. In order to be a world leader, and not just a spectator in this momentous transformation, the EU needs to act immediately, recovering the time lost chasing diesel technology. Only time will tell whether it will have the energy and political will to abtain this goal.

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