Europe is in trouble again – as an economic power, but also for many other reasons, such as migration and net zero. This statement is always met with the obvious response: “Isn’t that always true?” Can’t the same be said of the UK, US and China as well?
Answer: Yes. They are all becoming aware that the two years of increasing interest rates were not a temporary anomaly. The rates will remain high for longer and increase the debt service costs of governments that are already in fiscal difficulty.
The interest rates may have reached their peak, but central bankers made it clear over the last two weeks that , they won’t be falling significantly, for some time. This came as a surprise to the markets, who had assumed that interest rates would be cut from next year. Bond yields are rising again.
It’s only in Europe that it could be more serious because of the Euro. This monetary union, which is only partially formed more than 20 years after its creation and still fundamentally flawed, binds together fiscally sovereign nations.
This does not mean that the eurozone is headed for another collapse as it was during the peak of the sovereign debt crisis in 2009/10. Anglo-Saxons are always underestimating the political will in Europe to keep it going, no matter what the cost.
The fault lines have resurfaced despite the much higher rates of interest. This time, the European Central Bank is unlikely to be able to offer the same “whatever it costs” support in the form of unlimited bond purchases that helped save the single currency when it was on the verge of ruin.
Fiscal deficits should be limited to 3pc of national revenue under the no-bailout rule, which is designed to protect eurozone members like Germany who are more solvent from those less creditworthy. The Stability and Growth Pact also requires that national debt be reduced over time to 60pc.
Few people have been compliant consistently, including Germany and France. Their various violations of budget deficit limitations went unpunished, unfined.
Mario Draghi’s massive bond-buying programme, initiated in summer 2012 by the European Central Bank to save the Euro from oblivion, seemed to render the Maastricht Treaty no bailout clauses largely irrelevant. It amounted to the monetisation of mountains of government debt and thus mutualisation.
The pretense of fiscal discipline continued – up until the pandemic when the Stability Growth Pact was suspended, allowing nation states to spend as they wished to support lockdown. The plans to reimpose this pact by the end of the year were derailed due to the war in Ukraine and the massive energy subsidies put in place by governments in Europe to protect their citizens from inflationary effects.
The deadline has been extended again, until the end of the year. Fat chance. Once the floodgates were opened, it was inevitable that they would be difficult to close. Both Italy and France made it clear in their budget plans that they had no intention to make the necessary spending cuts required to bring the deficits up to the Maastricht requirements.
Giancarlo Giorgetti said in defiance last week that “we believe we’ve done the right thing.” We do not respect the 3pc limitation.”
They don’t. The 2023 deficit will rise to 5.3pc, up from the previous estimate of 4.5pc. The deficit will only improve marginally in 2024 to 4.3pc. It’s almost as if Georgia Meloni has transformed into Liz Truss. She’s not interested in fiscal rules and is determined to resist the recessionary effects of imposed fiscal contract.
France has also resisted the kind of cuts in spending that are needed to bring the deficit under control. Not only them. At least half of the eurozone’s members are expected to fall short of the 3pc threshold next year.
In the case of Italy, yields soared and spreads increased, returning to levels that were prevalent in the aftermath of the mini-banking crises in America earlier this year. Credit risk suddenly returns to the table.
The UK is not immune to the effects of higher interest rates, despite having a slightly higher rate of growth than most of Europe. The Government’s debt service costs have risen to their highest levels since the immediate post-war period, both in terms of government revenue and GDP.
The UK has its own currency, which acts as a natural mechanism for adjustment. A lower exchange rate can help absorb some of the pressure from “higher and longer”. In the eurozone where recessionary forces are gaining strength on all sides, particularly in Germany’s industrial heartlands, there is no relief.
It is curious that Germany, unlike France and Italy, has more than enough fiscal room to combat a shrinking economic with tax cuts and increased spending. Germany’s infrastructure is in dire need of repair, but it still cuts back on spending.
The ruling coalition in Germany shows no sign of wanting to break from the political consensus on “black zero”, which is running balanced budgets. Fiscal policy will tighten even more as a result of the current situation, which is a contraction in the economy.
Bring on the higher interest rates. This is the attitude of Berlin’s top brass. Low rates are only for sissies. He boasted that in the 1970s we built a lot of housing when interest rates were 9.5pc. Money was saved in the 1970s. “Irrespective of interest rates, the problem is not with interest rates”.
They are only sort of, because despite the fact that ultra-easy monetary policies saved the euro more than a ten years ago, rising prices have closed those options. Now, the only thing keeping the recessionary wolf at bay is the fiscal incontinence fueled by debt of Germany’s neighbors.
We will have to wait and see how tolerant the Germans can be. According to the results of the polls for Alternative for Germany, the answer may not be very much. The higher-for longer policy is threatening to rekindle Europe’s centrifugal force.