Can the Eurozone Survive Another Likely Recession?

In 2011, the eurozone survived a crisis that threatened its existence. Portugal, Ireland and Greece were provided with rescue packages and the President of the European Central Bank (ECB), Mario Draghi, was praised as a hero. In 2012, he said he would do ‘whatever it takes’ to save the euro. As he prepares to retire from his role this month, his long-term legacy on managing Europe’s single currency is questionable. He could not be leaving at a worse time as Germany tinkers on the verge of a recession.

One of his final acts is to introduce a stimulus package that will slash interest rates from -0.4 per cent to -0.5 per cent and resume quantitative easing (QE). His target is to ensure inflation remains below 2 per cent. Klaas Knot, the head of the Dutch central bank, referred to this measure as ‘disproportionate.’ The governors of the French and German central banks are also opposed to this stimulus package. By buying up bonds from toxic EU member states like Ireland, many governors are wondering if the ECB is now bypassing its own bylaws at the expense of ensuring the euro survives.

Furthermore, purchases have been unsuccessful. When the ECB bought a large number of Spanish government bonds last August, yields declined by more than a percentage point at first. But then yields drastically increased in value. Draghi’s plan has the risk of creating further division between the north and the south in the fragile equilibrium of the ECB’s Governing Council. Norbert Barthle, the CDU’s chief budgetary expert, told Spiegel Online that it is “not the central bank’s job to buy up government debt.” Representatives of the Mediterranean countries also suspect that the Bundesbank is becoming increasingly reluctant to bail out southern European countries and may contemplate returning to the Deutsche-mark.

The advantage for Mediterranean countries in 2011-12 was that larger economies like Germany were not experiencing a painful recession. Although the Dax index increased by 15 per cent this year, the German economy declined by 6.7 per cent. The Financial Times reports that the MSCI believes a no-deal Brexit would deliver a 5 per cent blow to German equities. Also, falling Chinese demand and Donald Trump’s threat of tariffs on European cars means the country’s stocks may crash. If the EU’s largest economy enters a recession, the eurozone is unlikely to survive.

The Spectator argues Germany must take bold fiscal action. The European Commission called for ‘pre-emptive, rather than reactive’, fiscal policy- which only Germany can deliver. If Merkel can help Boris secure a Brexit deal, that would partially relieve the EU’s economic anxiety. Andrew Sheng of the South China Morning Post suggests the eurozone needs a modern-day equivalent of the Marshall Plan and that Germany can provide it thanks to its huge budget surplus. He adds that the German Chancellor must accept that Greece’s debts are also Germany’s problem as long as the eurozone ‘family’ continues to exist.

Last year, Merkel proposed a strict eligibility criteria for a European Monetary Fund that excludes those nations failing to tackle their debts from receiving money. This attitude is consistent with Berlin’s hawkish outlook on the eurozone crisis. A sluggish German economy will only make the Chancellor more reluctant to bailout Mediterranean countries. But the EMF alone is unable to rescue the euro.

Today, Italian debt to GDP has risen to 130 per cent. The country is already facing a two trillion-euro financial crisis and the ECB can only buy 33 per cent of a nation’s debt. This means the central bank does not have enough cash to rescue the entire Italian economy. If Italy crashes out of the euro, it will struggle to repay its Target2 loans to Germany and damage the latter’s economy further. Some, like Nikolai Hubble, predict this could lead to a recession worse than 2008.

Therefore, no amount of German money could ever rescue the eurozone crisis. It is now a question of when, not if, the entire system collapses.