Who will pay the debt, which has grown to such unsustainable levels in just a few months time? We need a new way to deal with debt, and we are all in this together, says Nicolas Forest, head of fixed income at Candriam. ‘The main risk today is not to change anything.’
Today, at a time when the world is slowly moving out of lockdowns, we should start thinking about the future of monetary and budgetary policy in Europe. How can we still be a united monetary union with the Italian debt ratio being twice as high as Germany’s? Is it possible at all to return to the old ways once this crisis is over? Should we revive mass tourism, extreme globalisation, uncontrolled production and investment in oil? Should we respect the Maastricht criteria once again and demand fiscal austerity from the Italians at the price of their fight against the pandemic?
Over the next two years, the differences in debt ratios between the countries of the eurozone will increase - we are talking about differences of up to 100%. The countries most affected by the virus - Italy, France and Spain - are those that have applied the toughest lockdowns and, by extension, those whose debt has swollen the most. Conversely, Germany has been less affected and seems better positioned for a quick rebound.
So what are the options, then, for managing the debt overhang? We see four.
1 Reducing deficits and asking poor countries to take austerity measures. This option is not only politically and morally complicated; it is also economically dangerous. The Greek example showed that austerity could, paradoxically, increase debt.
2 Creating nominal growth and therefore inflation. Very easy to say… and very difficult to do, given demographics and productivity in Europe. At a time when savings rates are at their highest, a rebound in inflation seems unlikely in the short term.
3 Restructure excessively high debts. While this option could lower debt ratios, it would require banks and households, whose savings are heavily invested in government debt, to make enormous sacrifices. Such a restructuring would also be dramatic for the political sustainability of the euro area.
4 Mutualisation of debt. This is - in our opinion - by far the option most likely to have positive effects in the long term. The creation of eurobonds would make the euro area irreversible and create new budgetary room. This debt could be managed according to a two-tier system: a national tier managed by governments for domestic spending and a European tier for new spending related to the pandemic but also for new common structural spending, such as climate or migration policy.
One of the major challenges going forward will how we will go about the increase of inequality caused by this crisis. If governments insist on making the poorest and most affected states pay for the crisis all by themselves, this will cause huge problems and will encourage populism to come to power.
Furthermore, without debt pooling, the return to fiscal austerity in European countries will inevitably put the eurozone at risk. We risk to a return to the wave of defaults of the 1930s, the tragic consequences of the Versailles leitmotiv “Germany will pay” with possibly even more serious political consequences later on.
The main risk today is that nothing will change. Another model is possible.