Great timing for Disney to release the movie version of the Broadway success Hamilton, the musical, with European politicians preparing for their summit this week to discuss the European Recovery Fund (ERF). This Fund is set up to re-ignite the European economy after the damage done by the coronavirus and is a combination of grants and loans for a total size of 750 bn euro. Countries which have suffered most from the coronavirus will get the biggest claim on the fund. The question is whether the coronavirus crisis will result in the EU finally having its “Hamilton moment” by introducing the ERF. My answer to this question is negative, as I do not think that a significant expansion of the EU budget counts as a “full Hamilton”.
For those who missed the musical (or the book or the movie or history classes), Alexander Hamilton was one of the founding fathers of the United States and amongst his many contributions to create an effective and great union were his proposals to establish a central bank, a central currency and central government debt. So one might say that the EU is certainly on its way to becoming a true union as well, as we already managed to create a central currency and a central bank. All we need to do is to agree to common European sovereign debt and we are done. In my view, we are certainly taking steps towards an ever closer union as is promised in the EU Treaty, and agreeing to the ERF (and one might add finalizing the Brexit) is one of those many steps.
We should not forget that a mere decade ago, EU citizens were hoarding euro notes which were printed by the German Bundesbank and avoided the euro notes printed by other central banks. Same euro notes, same autograph of Trichet or Duisenberg, same face value, but the public put a premium on Northern European notes. At that time, we were also very close to losing a member of this currency union, something that is inconceivable in Hamilton's union.
Since the start of the sovereign crisis in 2008, financial markets have demonstrated the crisis behavior of EU citizens, hoarding German sovereign debt and demanding a significant yield premium on Southern European bonds. The Greek default and the subsequent rating actions on other EU countries revealed that common EU sovereign debt was still out of the question. In the last few years, the ECB has tried all it can to convince markets that all eurozone sovereign debt should be trading at similar yields. The Karlsruhe ruling showed the limitations of such "backdoor Hamilton", as is also visible in the rise of anti-euro political parties in Northern Europe. So if we want to have central government debt for the EU, it will be up to the politicians to agree to it.
This week, Merkel and Macron will try to push the EU in this direction, through a significant expansion of the medium- and longer-term EU budget. But the combination of budget expansion and gifts to EU countries is not the same as creating common sovereign debt. EU member states should look at the US' example and realize that the individual US states cannot run (indefinite) deficits and basically have to balance their budget, no matter what happens. Sure, they still have massive long-term obligations (pensions come to mind first and foremost) but they are not allowed to run up deficits and issue bonds Italy-style. Interesting, Republican leader Mitch McConnell recently suggested that US states should file for bankruptcy if their budgets explode due to the coronavirus. Apart from the fact that there is no bankruptcy procedure for states, this example shows that as long as government entities have debt (be it municipalities, US states or Italy), investors will continue to assess the possibility to get their money back on any of such debt. So even if we continue to expand the EU budget, Italian debt will be priced as a risk asset as long as it has an aura of unsustainability attached to it.
Be prepared for the unexpected
Back to the EU meeting this week. The major EU countries seem to agree to the Merkel/Macron plan and Dutch PM Mark Rutte (as the informal leader of the frugal four or five) has received many high-level visitors the last few weeks to persuade him to agree as well. EU decision making is quite opaque at the best of times and nerve-racking in crisis times. Last week the major EU countries received a slap on the wrist as their preferred candidate for the role of president of the Eurogroup of finance ministers (Nadia Calvino) was pushed aside by the Irish Paschal Donohoe, elected by a majority consisting mostly of the smaller countries in the eurozone. This is an example of the smaller countries becoming tired of the bigger countries dividing the major EU roles amongst themselves. But in my view it's also a clear example that decisions in the EU will continue to surprise analysts and markets. Hamilton, the musical, is a 2 hours and 50 minutes show. A similar musical for the EU hopefully is on its way, but the finale song still needs to be written.