De ‘slaven van het financiële systeem’ bij een act bij de ECB in Frankfurt, 2018.

De ‘slaven van het financiële systeem’ bij een act bij de ECB in Frankfurt, 2018. © AFP / Boris Roessler

Solidarity with Italy is also about saving the European banking sector

Dutch citizens have been asked to show solidarity with southern Europe. But Italy is not the only one needing help. If citizens do not provide financial support, the European banking sector is at risk of going under – again.

[This article was originally published on 6 April 2020.]

‘Repulsive, senseless and absolutely unacceptable.’ These were the words used by the Portuguese prime minister, António Costa, to describe the Dutch attitude during the emergency talks about the joint financing of the European crisis measures. The ‘poor’ southern European countries want Europe to jointly borrow money to save the European economy. Their position is diametrically opposed to the stance of the ‘rich’ northern Europeans, who are loath to see their financing costs increase.

This is an existential crisis for the European Union, or, in the words of Paul De Grauwe, a Belgian economist, in Belgian newspaper De Morgen: ‘If you are not prepared to help at this time, what on earth do we have a union for?’

Hoekstra pulls a Dijsselbloem

The tension among the euro countries is palpable. It all started on 24 March, when the Dutch finance minister, Wopke Hoekstra, pulled a Dijsselbloem. He asked the European Commission to investigate why some eurozone countries had managed to build financial buffers in the past years, while others had not.

A clumsy move from a diplomatic perspective, especially now with a pandemic spreading across the continent and with the European economy on its knees. Several days later, Hoekstra offered an apology: ‘I showed too little empathy.’

The crisis is no picnic for anyone, but German companies have a huge competitive advantage in comparison with their Italian competitors

Yearning for the home currency

Italy and Spain are amongst the European nations that have been hit hardest by the coronavirus. Their social life and business sector have come to a screeching halt. Yet it is the German government that has assigned the most funds in support of its national economy. The differences are huge: Germany has directly invested 150 billion in the German economy, compared to Italy’s 16 billion. If you also include state guarantees for loans plus deferral of taxes and social security contributions, the differences are even greater. The crisis is no picnic for anyone, but German companies have a huge competitive advantage in comparison with their Italian competitors.

Why is Italy not spending more? Sovereign governments can create unlimited money to stimulate the economy through public expenditure, tax reductions or helicopter money. That would have been an option if Italy still had the lire. But since the introduction of the single currency, the eurozone countries no longer have a national currency. They cannot independently print extra money to devalue their currency.

Eurozone countries have to borrow money on the private capital markets to be able to spend euros. That is a costly undertaking. To cover the risk, capital providers charge Italy and Spain a higher interest rate than the Netherlands and Germany. Their assessment is that Italy is at a higher risk than the Netherlands of collapsing under the debt burden. That reasoning is understandable: Italy has a public debt of 138 per cent of its gross domestic product (GDP), whereas the Netherlands’ national debt is only 51 per cent of the GDP.

A friend in need is a friend indeed

Southern European countries want Europe to jointly borrow money in the form of so-termed corona bonds, or through the European Stability Mechanism (ESM) in order to distribute the funds to the hardest-hit countries. It would make the interest rates more advantageous for these countries. (The Netherlands currently pays -0.04 per cent interest, against Italy’s 1.7 per cent.)

This would make borrowing more expensive for the Netherlands and Germany, to which minister Hoekstra objects: ‘We are not going ahead with the bonds. It will not solve any problems.’ For now, the Netherlands is also stonewalling the use of the ESM credit facilities. Instead, Hoekstra has proposed a one-off donation to the countries most affected: ‘We will roughly donate one billion euros as a token of solidarity.’

It is a nice gesture, but basic math tells us that this type of solidarity is a drop in the ocean. All European countries will have to borrow tens of billions, if not hundreds of billions on the capital markets. If they do not, their economies will collapse. As it stands, a solution for financing the European corona measures is still far away. A new euro crisis is looming.

European governments and the financial sector still have a symbiotic relationship

Italy’s debt is a time bomb

Why a euro crisis? The cabinet’s explanation does not mention anything other than the high interest rates for the Netherlands. The debate in the Dutch media has focused on the frame of European solidarity, or the lack thereof. The seriousness of the situation and the concerns of the banks, which are sweating bullets, remain undiscussed.

Italy has a public debt of over 2.4 trillion euros. The European Central Bank (ECB) has bought up a part of it through its ongoing Asset Purchase Programmes. This still leaves some 2000 billion in government bonds on the balance sheets of banks, pension funds and other investors. If Italy has to take out substantial additional loans to fight the corona crisis on top of the 300 billion it needs to refinance this year, it risks a downgrade of its credit rating. An interest rate increase could cause a meltdown on the financial markets. 

The 2000 billion in government bonds will decrease in value when the interest rate goes up, thus triggering a chain reaction. Evidently, Europe had not learned enough from the main lesson the credit crunch and eurozone crisis taught us about the danger of financial interconnectedness in the public-private domain. European governments and the financial sector still have a symbiotic relationship.

A substantial amount of the Italian government bonds are on the balance sheets of banks in Rome and Milan. The exposure of banks in the rest of Europe to Italian debt is also significant. According to a study by Bloomberg from last year European banks hold a combined 425 billion of sovereign and private Italian debt.  BNP Paribas (143 billion), Crédit Agricole (97 billion), Deutsche Bank (30 billion) and Commerzbank (12 billion).

Once the first domino is knocked down, the rest of the European banking sector will soon follow

A decrease in the value of bank assets will turn the current liquidity crisis at the banks into a solvency crisis: their assets’ value will be overshadowed by their financial obligations. The Italian banks will be the first to fall, but once the first domino is knocked down, it is likely that other European banks will soon follow – unless they receive state aid again. It is possible that minister Hoekstra wants to keep the ESM option open for that situation, even though the ESM capacity is bound to be insufficient in such a scenario. 


Back to Hoekstra’s question. Why have the southern nations failed to put their government finances in order in the past decade, and why have they not created a buffer like the Netherlands? Aside from Hoekstra’s diplomatic goof and his urge to take a political stand in this hectic crisis situation, it is a legitimate question.

‘Buffer’ is not really the appropriate word. According to the European Stability and Growth Pact, a nation’s public debt may not exceed 60 per cent of its GDP. In order to reach that percentage Italy would have to repay about 1300 billion euros, whereas the Netherlands still has room to spend about 80 billion. It is clear that creating Hoekstra’s ‘buffer’ is and never was a realistic option, no matter how much the country pays back.

Hoekstra’s question: why are Italy’s government finances in disarray?

Tax revenue

The Italian tax authority is struggling with serious problems. ‘The tax system is overly complex, applies high statutory rates on a base that has been significantly eroded through exemptions and incentives, and suffers from significant compliance gaps.’ The IMF estimates the tax gap at 109 billion euros, 6 per cent of the Italian GDP. The ‘shadow economy’ in Italy, which is not recorded, is estimated at 13 per cent. The informal economy in the Netherlands is 5.5 per cent.

The Italian treasury is further affected by tax deduction rules, which are used by rich, home-owning Italians, while employees in rented housing have to pay huge amounts in taxes. The average labour tax in Italy is 47.9 per cent, as opposed to the average 41.8 per cent in the eurozone.

The problem of Italy’s significant tax gap is not exclusively of its own making. David Adler, of the School of Transnational Governance, and Jerome Roos, a political economist at the London School of Economics, lashed out at Hoekstra in The Guardian. ‘The Netherlands has long been known as one of the world’s most infamous tax havens, siphoning off hundreds of billions of euros in corporate profits and international financial flows and keeping other governments from taxing them properly.’ They think our country is hypocritical: the Netherlands helps large Italian companies to evade Italian tax levies.

Exor, the investment vehicle of the Italian billionaire family Agnelli, with significant stakes in Fiat, Ferrari and The Economist, is one of these companies. Exor moved its headquarters to Amsterdam for tax purposes.

The ant and the cricket

Italy’s GDP per capita has been lagging seriously behind the other European countries since 2006. In 2018, ten years after the credit crunch, the level was even lower than in 2000.

On the whole, Italy’s productivity is lower than the European average. Before the credit crisis, the Italian wage increases had exceeded the growth of labour productivity. This was not corrected in the past decade, contributing to the low overall productivity of the country The IMF is mainly critical of the inefficiency of the public sector and the judiciary.

Pension expenditure is high and will continue to increase in the coming years. This weighs heavy on the government budgets. An ageing population, combined with low productivity and rising unemployment could render the generous pension entitlements untenable. The pensionable age in Italy is 66 years. While this is not very different from the Dutch situation, the OECD figures of 2018 show that the Italians, just behind the French and Spaniards, enjoy their pensions longer. 

Nevertheless, Italy’s domestic budget is in better shape than you would expect based on the foregoing. The Italian economy is supported by the fact that it is one of the largest exporting countries of Europe. Despite the shoddy tax collection and the high public expenditure, more money is coming in than going out year-on-year. Since 2009 Italy has not had a primary budget deficit in any year.

But Italy’s undoing is the high level of its public debt, and that it is therefore haemorrhaging money from its public purse. It flows to the holders of Italian government bonds – the Italian and European banks, pension funds and other investors – in the form of interest payments. The IMF writes: ‘High public debt is a persistent source of vulnerability, forcing Italy to run larger primary fiscal surpluses than its peers and limiting its ability to respond to shocks.’

[More information:  IMF Country Report: Italy, March 2020.]

Read more Fold in

The burden of high public debt

The answer to Hoekstra’s question is clear: Italy was unable to create a buffer due to the interest it had to pay on the high public debt. That is an inherited problem: between 1960 and 1990 Italy lived on credit, but in the past 30 years, except for the Great Recession of 2009, the country had primary fiscal surpluses.

The public debt weighs heavy on the shoulders of the current generation of working Italians. For the most part, the money goes to the Italian banks, and to banks and pension funds in the rest of Europe. The high public debt has dimmed the prospects of Italy’s youth. Italy spends less on education than the European average and employment prospects are poor. Even before the coronavirus crisis, unemployment in Italy – at 10 per cent – was three times higher than in the Netherlands.

The debt problem

‘We will  no longer be the rich north if the south collapses,’ said Nout Wellink in radio programme 1 op 1 on 30 March. As president of the Dutch National Bank (DNB) at the time of the credit crunch, he knows like no other what will happen with banks in situations like that: the Netherlands will not be spared. ‘Under the current circumstances this is a misconception. It is like a healthy man being engulfed by an avalanche. Being healthy is no longer relevant.’

At the current debt levels, more debts will slow economic development, deepen crises and impede recovery after a crisis

Over the past weeks, a lot of European economists have advocated eurobonds, the issuance of joint debt instruments to share the burden between all eurozone countries. And on 31 March, eighty ‘prominent’ Dutch economists, some of whom work at large Dutch banks, published a plea for ‘a joint financing of a European approach to the coronavirus crisis.’

Although ‘a joint financing of a European approach to the coronavirus crisis’ will undoubtedly lower the financing costs for Italy and Spain and will give the European banks some breathing space, this approach does not address the heart of the matter: the increase of the debt burdens, both public and private. This goes against the latest scientific insights and the warnings of the BIS, IMF, OECD and the DNB for a further rise of debt burdens. At the current debt levels, more debts will slow economic development, deepen crises and impede recovery after a crisis.

Tapping into the ESM or issuing ‘coronavirus eurobonds’ will distribute the pain, but does not address the debt virus; it is a painkiller, not a vaccine. The alternative of monetary financing – creating new money not financed by the issuance of debt, is being proposed by many scientists but remains underexposed in the public debate.

The frame of European solidarity is incorrect

The option of ‘a joint financing of a European approach to the corona crisis’ is presented as a choice for ‘solidarity’. And if we do not make that choice, we are headed for a scenario of ‘national catastrophe’.

But the careful observer sees that the choice is not black or white. First of all, the corona crisis has lifted the lid on the absence of a ‘European approach’. The Netherlands initially took a very different approach than its neighbouring countries. Social distancing is the policy of choice in the Netherlands, while other eurozone countries shut down their borders and imposed a lockdown. In Italy, all patients are placed on a ventilator, whereas in the Netherlands some patients are not treated, because treatment is not deemed useful in every case. Wearing surgical masks outdoors is compulsory in Austria, but is advised against in the Netherlands. Germany tests as many people as possible, but the Netherlands only a few. The political leaders of Europe have fiercely debated the financing of loans for the past week and a half, but the action plan to be financed remains unclear.

The Greek bailout was also presented as a show of ‘European solidarity’

The situation in the EU is not so different in normal times. Social facilities differ per country and even pensionable ages vary: in the Netherlands, people will soon have to work until the age of 67, while the pensionable age in France is 62. This makes debt mutualisation, the distribution of the debt burden, a sensitive issue – even as a crisis measure.

Solidarity is difficult to organise if the underlying conditions vary and have not been laid down beforehand. It is not for nothing that an insurance company defines beforehand in which cases it will pay out, and only does so if the premium has been paid every month.

Risk compensation

The last round of debt mutualisation is still fresh in our memory. Although during the last eurozone crisis ‘we’ did not save the ‘cricket Italians’ but the ‘lazy Greeks’. The Greek bailout was also presented as a show of ‘European solidarity’. To this day it remains a well-kept secret for many Europeans that the European citizens as a group were saddled with the non-performing loans of, mainly, French and German banks. ‘We’ saved banks and their financiers, not the Greek people.

In this eurozone crisis, the public debate is not just steering clear of monetary financing, but also of debt restructuring.

The austerity policy that was then imposed on the country by Europe caused the Greek economy to contract even more, and only increased its debt burden: to 180 per cent of the GDP, the highest in Europe. All because Europe was unwilling to discuss a better solution, namely a restructuring of existing debts.

The same pitfall is awaiting us again. In this eurozone crisis, the public debate is not just steering clear of monetary financing, but also of debt restructuring.

The subject everybody is tiptoeing around: there is a creditor to every debtor. If a debt burden becomes untenable, it should not just be a problem of the debtor alone. The creditor is also in trouble: he will have to write off debts. He has collected risk premiums for years to cover such a risk.

Risk and reward no longer run parallel in the current capitalist system. Whenever the wealthy class of shareholders is faced with accepting a loss, the situation is averted by distributing the pain over the rest of Europe. If the European capital holders are not willing to accept a loss – as prescribed by the rules of capitalism – future generations of Europeans will be forced to bear the debt burden to the end of time.