(Bloomberg) -- Euro-zone leaders who oppose sharing the costs of the coronavirus crisis might end up doing so anyway -- through the European Central Bank.
The idea that the ECB could absorb the massive debt that builds up in the recession is gaining traction among some economists. If done carefully and over a long period, they say, it could get around the legal ban on so-called monetary financing.
It could also be subtle enough to be palatable for countries such as Germany and the Netherlands, if the alternative is the collapse of the single currency.
“My impression is that, given the choice, these seemingly disciplinarian countries would rather go through the central bank than agree to debt mutualization,” said Gilles Moec, chief economist at AXA in London and former Bank of France official. “This thing seems to be so toxic politically for them that they would rather go through the back door, hoping that it’s so mightily complicated that no one will really understand.”
Governments the world over are grappling with how to fund their pandemic response, but there’s a unique twist in the euro zone. With no fiscal union -- the 19 member states each issue their own debt -- the crisis is testing the limits of the bloc’s solidarity.
That’ll be clear on Thursday, when leaders discuss potential responses to the slump. Fiscally conservative nations will almost certainly torpedo any suggestions for jointly issued debt known as eurobonds or coronabonds.
Even the pandemic can’t shake the fear among some politicians that bailing out their poorer cousins will cost them votes. Most fiscal action so far has been at national level, and European relief has taken the form of loans.
The upshot is that the debt burdens on countries such as Italy and Spain will surge, dragging on economic growth and raising the specter of a financial crisis if inflation picks up and the ECB is forced to raise interest rates. The International Monetary Fund reckons Italy’s debt-to-GDP ratio will be 155% after the pandemic, more than twice as much as Germany’s.
ECB Executive Board member Fabio Panetta, who is Italian, warned on Tuesday that financing costs must be pushed “very far” into the future, and that an uneven response risks undermining trust in the euro.
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The central bank is already helping out by skewing its asset purchases toward Italy to keep bond yields down, though yields have risen recently in a sign investors are testing how far it’ll go.
It has loosened its rules on what bonds are accepted under its purchase and collateral programs, and in a call on Wednesday may discuss accepting more non-investment-grade debt, known as junk. It already does so for Greece.
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Those measures are temporary and ultimately contribute to helping the ECB meet its mandate of keeping consumer prices stable. But they could become important for financial stability as well, according to Bank of America (NYSE:BAC) economist Ruben Segura-Cayuela.
Officials could pledge to hold onto the bonds for maybe 30 years, he said. While “politically charged,” that would keep the risk of a crisis at bay, yet stop short of an admission that the debt will never be repaid.
The ECB’s bond holdings are on track to total around 3.7 trillion euros ($4 trillion) by December, equivalent to about a third of euro-zone GDP. More than 1 trillion euros will be added in 2020 alone.
That goes a long way toward covering the 1.5 trillion euros of additional government spending that ECB Vice President Luis De Guindos, who is Spanish, reckons will be needed to fight the recession -- but only if it’s not repaid too soon.
It echoes Japan, which has effectively been monetizing debt for years. The Bank of Japan now holds 489 trillion yen ($4.5 trillion) of government bonds, equivalent to 89% of GDP.
“While the BOJ isn’t financing the government directly, it’s not too far off from that in how it’s actually functioning,” said economist Atsushi Takeda at Itochu Research Institute.
Slow Monetization
The same could be true of ECB purchases, as former IMF Chief Economist Olivier Blanchard and Jean Pisani-Ferry argued recently.
“This is just an internal transfer of risk from the holders of securities issued by the high debt country to the shareholders of the ECB,” they wrote. “It leads to some risk-sharing across euro members.”
That strategy could blow up. The idea that German and Dutch taxpayers wind up on the hook for Italian liabilities, albeit via a back door, could spur a backlash from many mainstream politicians in northern Europe, never mind the euroskeptic populists who’ve been the focus of concern in recent years.
Still, Moec says “slow debt monetization” is a viable option, and suggests the ECB could even buy the loans made by banks to companies and repackage them into 30-year loans at an interest rate of zero.
His inspiration is former ECB President Mario Draghi, who last month argued that much higher public debt will become a feature of the economy and require private debt cancellations.
“If you say the debt will be canceled, I’m a bit worried about the political discussion,” Moec said. “But if you say I turned a three-year loan into a 30-year loan, but in the end the ECB will seemingly be made whole, then it’s probably easier to sell.”
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