Is Europe’s stimulus spending out of control? One way forward is to patch up trade relations with China

The amount of money earmarked for European recovery is huge, with scant regard for the consequences
Both the European Union and China need more bilateral trade to stand any hope of a stronger recovery this year, but concessions and compromise will be needed

David Brown

Published: 10:15pm, 27 Jul 2020

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Europe might think the coronavirus crisis is abating but the problems are still piling up for the EU. Global markets were hailing last week’s European Union agreement on a new €750 billion (US$878 billion) coronavirus recovery fund, financed by joint bonds, as a historic step towards closer integration and the emergence of Europe as a new superstate.

But it was really another case of the classic European fudge and desperate last-minute wrangling and, already, political cracks are beginning to appear.

Fiscally frugal EU nations like the Netherlands, Austria, Denmark and Sweden are griping about the burgeoning cost of reflation and the Dutch are complaining that they will end up as the ATM for Europe. Meanwhile, there seems little accord on how resources will be shared among the weaker member nations.

If it’s a question of spreading the jam very thinly, then the door is left wide open for future bailouts to bolster Europe’s tottering economy down the line.

The worry is that Brussels’ stimulus spending is running out of control. The amount of money earmarked for European recovery is huge, with scant regard for the consequences. Much of Europe is steeped in recession, inflation is close to zero and the coronavirus crisis is far from over. Economic demand remains dead in the water and the big issue is who will pick up the bill for reflation.

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Down the road, it means bigger budget deficits, higher taxes and more bond-buying scheduled under the European Central Bank’s quantitative easing, or QE, scheme to pump more money into the economy.

The combined budget deficits of euro-zone governments for the 2020 financial year could amount to an estimated €1.3 trillion, roughly the same as the €1.35 trillion the ECB has pledged to inject into the system over the next year. Europe is living beyond its means and monetising more debt.

In Germany’s view, the ECB’s asset purchase programme was never intended to be a bottomless pit of money printing. German Bundesbank president Jens Weidmann thinks the decision by European leaders to issue joint debt to finance coronavirus aid should be an exception rather than the rule, and should not serve as a blueprint for the future.

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The €3 trillion in bond purchases already accumulated by the ECB since the inception of QE in late 2014 sits uncomfortably with Europe’s monetary hawks and, as such, shouldn’t be relied on to extend forever. In their view, debt monetisation is an anathema for ECB credibility and negative for the euro.

Meanwhile, the main architects of the reflation package, German Chancellor Angela Merkel and French President Emmanuel Macron, both seem to be losing sway with sceptical voters at home and with European partners who are increasingly concerned about the growing burden on taxpayers, governments and financial markets.

The deal-making magic can’t last forever, especially with Merkel, Europe’s most influential power broker, set to leave office in 2021. At a time when European unity is needed most, the political cracks are widening.

It is no surprise that the euro’s post-deal rally has been so muted in the past week, moving only two big figures to 1.1650 versus the US dollar. The rally is more of a mild short squeeze than a battle cry for better times ahead.

With Europe’s economy on the ropes and European politics becoming more inwardly focused, Washington and Beijing must be left wondering what hopes remain for a thawing in future tripartite trade relations.

Trade frictions between Europe, the United States and China have worsened so much in recent years that a breakthrough is needed soon if the global economy and world financial markets are to stand any chance of a sustainable recovery.

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With Washington and Beijing recently falling back into a political stand-off, there could be an opportunity for Europe and China to patch up their differences and commit to better trading relations. Both economies need the free flow of faster bilateral trade to stand any hope of stronger recovery later this year, but concessions and compromise will be needed.

If Brussels and Beijing can set the gold standard for better trading relations and more open markets, then Washington may be persuaded to rejoin the fray, once the November US elections are over. Domestic reflation is one thing, but if the US, China and Europe can agree on a common ground for export recovery, so much the better for global growth in the future.

While it’s tempting to focus on domestic solutions, the way to a longer-lasting global recovery lies in a much more stable and secure world.

David Brown is the chief executive of New View Economics

This article appeared in the South China Morning Post print edition as: Europe is storing up problems that the world could do without

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