Today I wish to look at what may well turn out to be rather an epoch making moment for both the European Union and the Euro area. It starts with something rather awkward in terms of economics as we wonder what did they do with all the money here?
“European countries collectively saved hundreds of billions of euros a year in recent decades — a postwar “peace dividend” — as they drove down defence spending and freed up resources for other priorities including their welfare states. ( Financial Times)
With the recent debate in the upper echelons of the European Union about its poor economic growth performance there is rather an immediate fear that Arcade Fire may be playing.
If I could have it back
All the time that we wasted
I’d only waste it again
If I could have it back
You know I would love to waste it again
Waste it again and again and again.
Of course as this is from the Financial Times such questions are not asked. But there has been a large implied windfall from this.
Spending at this level between 1995 and 2023 would have required EU member states to allocate an extra $387bn a year to defence, according to Financial Times calculations based on 2020 purchasing power parity (PPP) dollars..
Now we see that the times they are a changing.
While the EU spends slightly less than 2 per cent of its GDP on defence today, European leaders are openly debating lifting spending to as much as 3.5 per cent of GDP or higher in the coming decade, a level not seen in continental Europe since the late 1960s. ( Financial Times)
The issue here as my country the UK is about to see today is how do you pay for this? One route is potentially via welfare cuts which we will see in the UK later but we know it is much easier to raise spending here than to cut it.
France’s efforts to tackle pensions spending have repeatedly sparked mass protests, including in 2023, when President Emmanuel Macron rammed through a two-year increase in the retirement age that aimed eventually to save about €18bn a year. ( FT)
Actually when we looked at the details of the reflationary plans for Germany we saw that there were plans for an increase in the welfare state. So it is a more complex issue that they want us to think. There is also another issue to look at.
A complete U-Turn by the European Commission
Here is the European Commission from the 17th of January as it sent instructions to France.
the general government deficit is expected to decrease from 6.2% of GDP in 2024 to 2.4% by 2031. In its plan, France expects the deficit to fall below the 3% deficit reference value earlier, in 2029, based on the plan’s assumptions.
As you can see this is the long-term plan of the Stability and Growth Pact where annual fiscal deficits should be below 3% of GDP per annum.
Now less than two months later the European Commission President tells us this.
European Commission president Ursula von der Leyen has proposed exempting €800bn in additional borrowing by EU governments from the bloc’s rules on debts and deficits. (FT)
It is again magic as spending is excluded from the deficit and debt calculations. A bit like in the Greek crisis as we saw the advent of Special Purpose Vehicles or SPVs. But that was on a smaller scale and if we stay with Greece for a moment which has what so far has been a permanently smaller economy the obvious question is how can it afford more defence spending? After all much of its debt was put in these SPVs and was kicked into the 2030s and 2040s into which time period the extra defence spending will arrive.
But overall we see a situation where austerity or at least the Growth and Stability Pact version of it has been replaced by fiscal reflation.
Debt Problems
Concerns about this issue have been raised in the Netherlands.
Europe’s borrowing binge to scale up its defence industry risks a new debt crisis, a leading Dutch politician has warned.
Pieter Omtzigt, who heads one of the parties in the four-way coalition government, told the Financial Times that a plan to generate up to €800bn in military spending approved by EU leaders this month would push up interest rates and government debt levels in the bloc. (FT)
Actually this has already begun to happen as we have been watching this.
When Germany, which has lower debt levels, announced plans on March 5 to run bigger deficits to re-arm and invest in infrastructure, yields on its bonds rose 40 basis points in two days. They remain above pre-announcement levels.
The FT is being a little mealy mouthed here as German bond yields in fact remain virtually exactly 0.4% higher. For once a clear example for economics text books of the price of a fiscal stimulus. If we switch back to the Netherlands we see a similar picture with its ten-year benchmark yield now nudging 3% as opposed to 2.6% or so before the changes.It is also keen to emphasis European Commission involvement.
To fuel the rearmament, the commission is also raising €150bn with its own top credit rating, which will be disbursed to capitals in the form of cheap loans.
That “top credit rating” is something of a minor gain for the Netherlands as it is some 0.2% cheaper than its benchmark bond yield at 2.8% and may well tighten if the European Commission borrows more. Is it rude to point out that as recently as the 17th of January the European Commission was instructing France to cut spending?
Rising interest rates will add €30bn annually to the EU budget from 2028 in repayments and interest, about a sixth of the total.
Also the Netherlands seems to be facing the sort of experience that led those nasty Brits to Brexit.
“We are afraid” the recovery fund will be replicated for defence, Omtzigt said. He said the Netherlands received about €5bn of recovery funds but will pay about €35bn of the related debt, because of its successful economy.(FT)
Comment
I find myself returning to what has become a long-running theme. We see Pieter Omtzigt deploying the Greek klaxon.
Public deficits would “explode”, he said. “Countries will get further indebted when they are already incredibly indebted compared to the rest of the world,” he said. “Maybe our Greek friends can tell you what the price of that is at some point for your own population.” (FT).
As ever there are also claims about events being a one-off.
Omtzigt said The Hague would remain staunchly opposed to another joint borrowing effort, pointing out the Netherlands only agreed to a pandemic-era €800bn recovery fund backed by joint debt on condition that it would be a one-off. ( FT)
We always seem to be in an emergency these days don’t we?
Apologies for the later posting today but WordPress was down.