As EU leaders strive toward ending the economic crisis sparked by the coronavirus pandemic, the German Constitutional Court has created an obstacle for the European Central Bank (ECB) which is buying the bonds of indebted southern European countries at an alarming pace.

Economy and Financial Affairs Commissioner Paolo Gentiloni said the best way to prevent the collapse of the EU’s single market is through joint European action.

The Bundesbank May No Longer Help the ECB

Germany’s Constitutional Court ruled on Tuesday that the European Central Bank (ECB) must clarify how the EU’s bond-buying scheme to support the eurozone economy is “proportionate,” or else Germany’s central bank, the Bundesbank, may no longer participate in it.

Furthermore, the Bundesbank will be excluded from joining the quantitative easing asset purchase program in three months’ time unless the ECB’s Governing Council adopts a new decision that proves that the monetary policy objectives pursued by the central bank are not disproportionate, the Constitutional Court said.

The ECB responded to the Constitutional Court’s statement by stating that it remains fully committed to doing everything necessary within its power to ensure that inflation increases to levels consistent with its medium-term aim. It added that the monetary policy action taken in pursuit of the aim of preserving price stability is transmitted to all parts of the economy and to all jurisdictions of the eurozone.

Dark Times for the EU

However, this is a troubling time for the EU. It was Germany’s ability to finance the debts of countries like Greece, Spain, Portugal, Ireland and Italy that rescued the eurozone in 2012. Considering southern Europe’s debts keep rising to unprecedented levels, it is understandable why Germany’s political institutions have intervened to question the EU’s current financial path. The coronavirus is shattering the eurozone’s ability to survive and without German money, it is impossible for it to do so.

Even the EU’s executive arm, the European Commission (EC), warned that the coronavirus has triggered the deepest economic downturn in its history. According to Bloomberg, the EC is convinced that COVID-19 threatens the euro’s future if the crisis is handled badly.

The eurozone is set to shrink by 7.7 percent this year, which would send unemployment and public debt levels surging. Officials warned that the crisis could widen the gulf between northern and southern European countries and push the bloc to breaking point due to varying exposures to the tourism industry and governments’ capacity to support households and businesses.

Economic output in Greece, Spain and Italy may fall by more than 9 percent this year, while it could be less than 7 percent in Germany and the Netherlands.

Prior to the coronavirus, the eurozone area was set to grow by 1.2 percent.

Without Joint Action the Eurozone Could Collapse

Gentiloni is right to warn that without joint action, the eurozone could collapse. Prior to the Constitutional Court’s decision, EU leaders were divided over what type of joint action is needed to tackle the bloc’s economic stagnation. Italy and Spain favor so-called “coronabonds,” a form of debt-sharing, while Germany and the Netherlands are opposed to this idea.

A crucial meeting this month will determine whether the EU is capable of joint action. Regardless of whether EU leaders agree on anything, the euro’s prospects are dire.

Until a way can be found to overcome the Constitutional Court’s opposition, it is unclear where the EU goes next. Time is running out for its leaders to agree upon a joint solution that is both financially sustainable and acceptable for all member states.

The coronavirus has tested the EU’s limits as a bloc and its leaders are on the verge of determining its future forever. Even if Germany and the Netherlands eventually agree to a form of joint action, there will come a time where their voters and institutions will no longer tolerate their financing of southern European debts, and it is clear that moment is fast approaching.

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In the discussion about further financial aid for Europe’s economy to deal with the economic fallout of COVID-19, head of the European Stability Mechanism (ESM) Klaus Regling has stated that  “at least another 500 billion” from European institutions will be needed.

Previous Agreement

A fortnight ago, European finance ministers had already reached an agreement after difficult negotiations on a COVID-19 rescue package worth €500 billion, which comprises three mechanisms: loans from the European Investment Bank for small and medium-sized companies, a European furlough work allowance, and precautionary credit lines from the ESM rescue fund.

However, in view of the damage caused by the pandemic and the fact that that damage will continue, the amount of the contribution appeared to be limited ab initio ⁠— especially as IMF projections see the EU economy plunging by 7.5 percent.

Further support through the European Recovery Fund ⁠— a so-called reconstruction fund for the economy ⁠— is also under discussion. Here, the EU Commission recently contemplated a volume of €1.5 trillion, which is €1 billion beyond Regling’s suggestion.

Regling’s Strong Support from Germany

In addition to the amount in question, Regling emphasized that new measures had to be discussed impartially, but that existing institutions had to be utilized primarily because doing so will be “easier.”

In Germany, Regling’s idea has particularly strong support. In fact, Germany’s finance minister Scholz has long been advocating for a coordinated European economic stimulus package. As a result, Scholz had already concurred upon a proposal by the EU Commission for the European Recovery Fund at the Eurogroup’s previous meeting.

Key Details Still Need to be Worked Out

The willingness to invest thus exists in spirit. However, the crux of the actual volume and how it would be financed, continue to divide Europe these days. The from southern states favored the idea of eurobonds has been rejected not only by Germany but also by Regling, who fears that it would take too long for it to be facilitated.

Scholz, meanwhile, also has constitutional concerns regarding eurobonds. With Germany becoming fully liable for any failed payments of other nations, Germany’s Federal Constitutional Court could intervene rather swiftly, as applicable German law may be violated. Germany’s government is thus in favor of facilitating the European Recovery Fund via quasi bonds that are guaranteed by a European institution with, such as Regling’s ESM. It would allow for leveraging the funds, in other words it would make it conceivable to utilize them more than once. Moreover, the fund is also said to be part of the regular EU budget.

Italy’s Position on the ESM

Italy, meanwhile, continues to differ. The Five Star Movement fundamentally rejects the use of the ESM, while other voices of the government have started to deviate from Prime Minister Giuseppe Conte’s dictum. According to Conte, Italy does not need the ESM as it is not a “suitable instrument” for overcoming the fallout, and the Eurogroup’s first plan regarding a recovery fund was thus “inadequate.”

Elsewhere in Europe, the choice of words has become much more conciliatory. In Spain, for instance, Prime Minister Pedro Sánchez praised the efforts taken so far. In a speech on Saturday, he stated that the meetings with the heads of state and government of the European Union were “bearing fruit.”

The Spanish government was no longer seeking to change the agreement already reached within the European Union, though it will demand that all programs be implemented as soon as practicable.

Accordingly, the Spanish government will present its own proposal for a joint financing option at the European summit starting today. Other nations will do the same to find a solution that is acceptable for parts of Europe that have been hit the hardest and the fiscally conservative nations such as Germany.

However, people should make no mistake. As much as the European Union has emphasized its commitment to unity and solidarity for the better part of its history, the upcoming EU summit will be dominated by division based on the different needs in what has arguably become the union’s most significant challenge since its creation.

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EU leaders are bracing themselves for another tough week as the coronavirus continues to take its toll on Europe’s health and economy. On Monday, Italy’s borrowing costs rose again as investors anxiously await a crucial EU meeting on Thursday where member states will try to draft an agreement on how to tackle the economic fallout from COVID-19.

Italian Debt Has Investors Worried

Investors are beginning to fear that holding on to the Italian Government’s debt is becoming a riskier prospect as yields continue to rise whilst prices fall. The yield on Italy’s ten-year bond has increased by ten basis points (0.10 percentage points) on Monday morning to 1.881 percent. This is close to the one month highs from last week.

Investors are already selling off Spanish and Portuguese government debt as Spain’s 10-year yield rose by 3.5 basis points to 0.837 percent and Portugal’s 10-year yield increased by 2.7 basis points to 0.984 percent.

The EU is At Odds Over Coronabonds

The main reason behind all this economic uncertainty is the disagreement over coronabonds, which nations such as France, Italy, Spain and Portugal are in favor of because these bonds will allow debt to be spread across the eurozone to ease their financial burdens, but other member states such as Germany and the Netherlands are opposed to them because their voters will never tolerate their money being used to finance poorer countries.

Italian Prime Minister Giuseppe Conte joined his French counterpart Emmanuel Macron on Sunday in calling for the issuance of $1.6 trillion of joint bonds to help economies damaged by the coronavirus ahead of Thursday’s virtual meeting.

It is becoming clear that more money is required to revive growth in the eurozone, despite the EU providing a €3 trillion fund to soften the blow from the pandemic, European Commission (EC) President Ursula von der Leyen admitted.

According to Bloomberg, Spain proposed creating a European fund worth approximately €1.5 trillion on top of relief efforts EU member states have already agreed to. The fund would be financed through perpetual EU bonds to ensure that national public debt levels are kept in check. Grants would be made available to member states through the EU budget.

The ECB Proposes Creation of a ‘Bad Bank’

Yet another idea that is being floated is a eurozone ‘bad bank’ to deal with bad loans. This is a scheme that the European Central Bank (ECB) and the EC are pondering. The idea is that non-performing loans would be removed from banks’ balance sheets.

The plan is to eradicate all debts that were accumulated during the 2008 financial crisis. ECB officials believe that if EU leaders can agree to this scheme, it will prevent banks’ lending capacity from being hindered and stop another surge in bad debts. It sounds like a good idea in principle, but it has already encountered numerous problems.

Although von der Leyen admits that more money is needed to stimulate growth in the eurozone, the EC as a whole is not keen on a ‘bad bank.’ If one of the EU’s main institutions cannot budge on their position and there is no breakthrough in general on Thursday, this will send jitters throughout the market.

The EU is About to Make one of the Most Important Financial Decisions in its History

Yet proponents argue that the ‘bad bank’ idea will allow toxic loans to be sold into the market after a fixed time period, with the power to recoup any losses from the lenders themselves.

Whatever the outcome of Thursday’s meeting, there will be considerable pressure to please the Italian Government. Conte is under pressure from his Five Star Movement coalition partners that have long campaigned against unacceptable loan conditions.

If the EU’s final agreement fails to please most Italians, it could result in a surge of support for Matteo Salvini’s League.

The ECB’s ‘bad bank’ idea has some merits and disadvantages, but EU leaders will be making one of the most important financial decisions the bloc has made so far on Thursday. Italy’s reaction to Thursday’s meeting will be the most important one to monitor.

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French President Emmanuel Macron provided a stark warning to his EU counterparts on Friday as he warned that the bloc is facing a “moment of truth.” He is arguing that the COVID-19 crisis has strengthened the need for greater solidarity among EU member states, particularly those nations that are most vulnerable to the economic effects of the virus, which includes Spain, Italy and Portugal.

The French leader added that now was the appropriate time for coronabonds to be issued which would pool member states’ debt and lessen the burden on them. The bloc could then issue common debt with a common guarantee. However, Austria, the Netherlands and Germany all oppose this plan.

The Disagreement Over Coronabonds

As the European Commission’s President Ursula von der Leyen was forced to issue a heartfelt apology to Italy for the way that the EU has responded to the country’s plea for help during this time, Macron believes that if the bloc cannot agree to issue indebted nations with coronabonds, it will spell the end of the eurozone.

Earlier this month, EU finance ministers finally managed to agree upon a £438 billion support package for nations most affected by the pandemic and they will benefit from €240 billion of credit lines via the European Stability Mechanism. Yet these measures have failed to stem the continuing tensions between northern and southern European countries over coronabonds.

Coronabonds Can Either Save or Sink the Eurozone

As Bloomberg‘s Andreas Kluth argues, the coronabonds can either save or sink the eurozone. Nations such as Spain and Italy, which are suffering the most from the coronavirus, would get cheaper access to the money they need to recover. Germany, which borrows at negative rates, would only pay trivially higher interest costs. Yet these situations are never that easy.

The tax revenues to repay the bonds would still be generated by the individual member states, and national legislatures would decide how to tax and spend. Northern European countries may fear that the southern parliaments may tax too little and spend too much, knowing that it would be nations like Germany that would have to repay their creditors.

Where Does the Eurozone Go Next?

Kluth highlights that there are two ways the eurozone could be destroyed in the future. The north balks at all forms of debt issuance, which would then lead to a surge in support for politicians like Matteo Salvini, who takes his country off the euro and accepts cash from China.

Alternatively, because many northern European countries resent having to pay for the south through a transfer union, northern nationalist governments could end up quitting the eurozone instead.

In theory, the eurozone needs a government that can issue bonds and levy taxes, but there is no guarantee all the EU member states can agree upon creating one, especially if more nationalist governments are elected in the future.

Either way, Macron is right — a profound agreement has to emerge from this crisis, otherwise the fragile EU’s chances of collapsing will increase.

Eurozone Leaders Have Limited Options

Italy’s dilemma also raises the possibility of a parallel currency emerging in the future. The Bruges Group’s spokesman Robert Oulds explained to Express.co.uk that because of the north’s reluctance to finance coronabonds, the Italian Government must look at issuing a parallel currency to prepare for a gradual exit from the eurozone.

He added that if the EU forces Italy to raise its taxes and cut spending, their economy is only likely to worsen, which is why a parallel currency is so necessary.

Regardless of which path eurozone leaders take, either one has risks and could result in a surge of nationalist support north or south of the EU. Further steps toward integration are likely to fall upon deaf ears in nations such as Poland and Hungary. Right now EU leaders are damned if they do and damned if they don’t.

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After prolonged and difficult negotiations, including verbal confrontations between Italy and Germany, Europe has found its first united response to the economic crisis caused by COVID-19.

Eurogroup Rides to the Rescue

On Thursday evening, Europe’s finance ministers – the Eurogroup – agreed on an aid package which primarily seeks to mitigate the crisis’s impact on workers, companies, and European states, by investing more than €500 billion.

Eurogroup chair Mario Centeno spoke of the epochal agreement, which he said took a “huge effort” but was nonetheless “facilitated quickly.” However, the Eurogroup needed three days and various rounds of negotiation to conjure an agreement. Even more important: decisions on crucial issues were postponed in order to finalize the aid package immediately – including the question of joint debts via Eurobonds.

Specifics of the New Agreement

The agreement now adopted contains three elements. The first component is made up of precautionary credit lines of up to €240 billion from the European Stability Mechanism (ESM). The ESM was created in 2012 at the height of the past Euro debt crisis. Secured by deposits from the Euro states, it borrows capital on the market and passes it on under certain conditions to countries that would have to pay higher interest rates on the market themselves or would no longer receive loans.

Secondly, the European Investment Bank (EIB) will create a fund for companies affected by the crisis. The EU states are to participate in accordance with their EIB shares. The fund is expected to mobilize up to €200 billion through levers and guarantees.

Thirdly, a furlough program coined “SURE,” which proposed by the EU Commission and is worth €100 billion will be implemented. Above all, it intends to provide financial security for national furlough schemes and encourage those EU member states who do not yet offer any furlough work benefit schemes to consider and create them.

The Agreement Was Not Easy to Reach

Despite the newfound temporary unity, the Eurogroup faced internal dissent on many propositions, particularly regarding the conditions attached to aid. For example, the Netherlands sought stringent conditions to access the ESM credit lines. Italy, in particular, opposed the idea. The compromise that has been facilitated now stipulates that although the ESM credits are unconditional, the funding can only be utilized for direct and indirect health costs. In the event that money is needed from the ESM for the economic consequences of the crisis, the usual strict reform commitments would apply.

Besides these elements, the ministers also seek to pave the way for a post-crisis recovery program. It is intended to become part or appendix to the seven-year EU budget that is currently being discussed. The fund is to be filled with several hundred billion euros. Common European bonds – the so-called Eurobonds – remain an option, at least in theory. However, two prominent figures did immediately reiterate their opposition to any Eurobonds agreements. Netherland’s finance minister Wopke Hoekstra emphasized that he did not consider Eurobonds an option and received support from German Chancellor Angela Merkel, who also repeated her stance. Merkel did, however, praise the agreement made yesterday. In addition, she pledged Germany’s participation in any additional economic stimulus program.

What’s the Next Step?

While the agreement is undoubtedly a first step in the right direction, many details remain open. Moreover, the package finally agreed to is smaller than the European Central Bank had urged. Its estimates were put at €1.5 trillion – triple the amount the EU has agreed upon now. The discrepancy could become a reason for concern.

The wording in the agreement is deliberately vague and allows for interpretation, particularly regarding future Eurobonds. However, it will now be up to the EU Council to take the next step and follow up with a post-crisis program, which could be discussed next week already. At this stage, it seems inconceivable, however, that a quick compromise and agreement between the southern states and the fiscally-conservative north is realistic.

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The coronavirus has exposed the deep divisions within the EU as they struggled to agree upon appropriate fiscal measures designed to save the bloc from the economic impact of this pandemic. On Thursday, EU finance ministers finally managed to agree upon a £438 billion support package for countries most affected by the epidemic and they will benefit from €240 billion of credit lines via the European Stability Mechanism.

The road to this agreement has not been easy. According to Reuters, the main reason for the breakdown of talks between EU finance ministers on Tuesday was a diplomatic feud between Italy and the Netherlands over what conditions should be attached to Eurozone credit for administrations battling the pandemic. This feud resulted in half a trillion euros worth of aid being blocked. This was meant to be an opportunity to move on from the fights that have shadowed the bloc over the last ten years, but Tuesday’s meeting failed to produce any groundbreaking results.

Spain, Italy and France Feel Like the EU is Not Doing Enough

The Dutch were particularly angry that the Italians wanted a reference to debt mutualization as a possible recovery instrument to be analyzed more in the future in the form of so-called “Coronabonds.”

Furthermore, Austria, Denmark and Finland also supported Holland’s stance on Coronabonds, despite the fact that German newspaper Bild, which opposed the Greek bailout ten years ago, urged the EU to help its southern members. This represents a dramatic shift in public opinion in Germany.

Spain, France and Italy already feel like the EU’s suspension of state aid limits that allowed member states to inflate their debt to spend more was not enough to help these struggling nations. The French were demanding that the bloc creates an emergency support fund issuing grants for medical supplies and healthcare.

Options Available to the EU

Other ideas that were being floated included credit lines from the Eurozone bailout fund that would be worth up to 2 percent of a country’s economic output; allowing the European Investment Bank to improve its lending by supporting companies with a further €200 billion; and to support the EU’s executive in raising €100 billion on the market.

French Finance Minister Bruno Le Maire told journalists that whilst an agreement was emerging on these three options, a fund worth “several hundred billion Euros” in joint borrowing would be sufficient to finance an economic recovery.

Is the EU moving fast enough?

ECB governing member Francois Villeroy de Galhau was quick to reassure the markets on Tuesday by saying that as the talks continued on Thursday morning, he hoped to make significant progress by that point, even if the Italians refuse to budge on Coronabonds.

Despite the fact that EU member states were able to come to an agreement on Thursday, Covid-19 has exposed the substantial economic differences between all of its participant states, and it has demonstrated how slow the bloc is in responding to economic crises.

Italians Feel Betrayed by the EU

Prior to this epidemic, Italy’s public debt was 133 percent of its GDP, or $2.3 trillion. Earlier on, a group of Italian mayors and other politicians bought a page in Germany’s Frankfurter Allgemeine Zeitung newspaper to remind Germany that it was never forced to pay back its debts after World War Two. With the League’s Matteo Salvini already taking advantage of this situation to boost his own popularity, it seems like EU resentment in Italy is only likely to surge in the long-term.

Regardless of the long-term impact of Brussels’ financial measures, many Italians are likely to remember this moment as a time when other Eurozone members failed to come to its rescue, and this will weaken the bloc’s support in Italy.

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