Europe at Debt’s Door

Hans-Werner Sinn

The Jordan Times (ref. Project Syndicate, February 7th, 2023), February 9th, 2023.

The European Commission’s ongoing borrowing spree is economically irresponsible and clearly inflationary. By continuing to issue common bonds to finance its expenditures, the Commission is harming European savers and undermining the creditworthiness of national governments.

Hit hard by the COVID-19 pandemic and the war in Ukraine, the European Union needs money. And given that Paolo Gentiloni, the bloc’s economy commissioner, cannot get it directly from the EU’s member states, he wants to borrow it. The purpose does not seem to matter. What matters is that the Commission receives money – lots of it – even if that means amassing a mountain of debt.

In 2020, Gentiloni played a key role in creating NextGenerationEU (NGEU), the emergency program that enabled the EU to borrow over €800 billion ($858 billion) to deal with the effects of the COVID-19 pandemic. Last May, he wanted to raise funds to aid Ukraine, and in October he suggested issuing joint debt to help European citizens with their gas bills. Now, amid a wave of common debt issuances, the European Commission plans to compete with US President Joe Biden’s $369 billion Inflation Reduction Act, which includes subsidies for clean-energy projects. While the new plan might not involve new borrowing, it proposes a new “European sovereignty fund” to invest in green technologies.

It is doubtful that the benefits of these programs will justify their costs. For example, there seems to be no correlation between the distribution of NGEU funds and the severity of local COVID-19 outbreaks. There is, however, a negative correlation between NGEU aid and GDP per capita, with some of the poorer countries that were less affected by the virus received staggering amounts of money.

The problem with the Commission’s current borrowing spree is that the EU’s own rules bar it from taking on debt. Article 311 of the Treaty on the Functioning of the European Union clearly states that the EU must finance itself “wholly from own resources.” That is why member states needed to agree unanimously to NGEU’s creation.

Another major problem is the lack of clarity about who will bear the cost of this debt. Politicians and economists often say that the EU’s debt burden will inevitably fall on future generations of taxpayers, who will have to service it. While there is some truth to this, today’s savers will pay the highest price. Like most of the developed world, Europe is reeling from the return of stagflation. In a stagflationary environment, unexpected events (like the war in Ukraine or COVID-19) create supply shocks that translate into rising prices due to excess demand. Issuing new debt creates more demand, thus further fueling inflation.

While price growth seems to be slowing, eurozone inflation is still at 8.5% – four times higher than the European Central Bank’s 2% target – and could spike again. Most recently, the core inflation rate, which excludes volatile food and energy prices, has increased to 7%, much more than anticipated.

During the stagflationary decade of the 1970s, it took a while for a wage-price spiral to take hold. With no end in sight for the war in Ukraine and the steady exit of baby boomers from the work force, high inflation is likely here to stay.

The persistence of high inflation makes pensioners who saved diligently for old age, together with savers who put their money into nominal-value-secured assets such as life insurance, the real victims of Europe’s indebtedness. The distributional effects could turn out to be profound, if not disastrous.

In his memoir The World of Yesterday, the Austrian writer Stefan Zweig vividly described how the hyperinflation of the 1920s impoverished and radicalized the petty bourgeoisie. Nothing, he wrote, made the Germans so “hateful and ripe for Hitler” as inflation. The American historian Gerald Feldman corroborated this observation in his seminal 1997 book on German inflation, The Great Disorder.

To be sure, today’s inflationary surge is nothing like the hyperinflation crises of the early twentieth century. But every inflationary episode starts small. The trick is to nip it in the bud before it spirals out of control. As the Romans would say, principiis obsta (“resist the beginning”).

The European Commission’s plans to raise billions by issuing long-term EU bonds are legally questionable and economically irresponsible. This borrowing, for which new justifications are constantly being sought, is clearly inflationary. Moreover, the Commission’s approach could undermine European stability and endanger the single currency.

If it continued on its current path, the EU would harm the creditworthiness of European government bonds. When former UK Prime Minister Liz Truss similarly ignored all warnings and sought to increase Britain’s already-elevated national debt with her disastrous tax-cut proposal last year, she spooked investors, crashed the pound, and was quickly shown the door.

Central bankers in Europe and the US have been raising interest rates aggressively over the past 18 months to tame inflation. Following through on Gentiloni’s plans would undermine these efforts. Any new debt is now inflationary and thus potentially devastating for the stability of the euro.

All of this is not to say that policymakers should not pursue worthy causes. But in a stagflationary environment, the way to do so is through taxes or other expenditure cuts – not debt. If the European Commission needs money, it should ask the national parliaments of its member states. And if they refuse, the EU must not borrow it. To do otherwise would put the dream of European unification at risk.

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