This Eurozone Crisis Will Be Even Worse Than Last Time

European Commission president Ursula von der Leyen has apologized to Italy for the EU’s underwhelming response to coronavirus. But faced with economic meltdown, battle lines are hardening between the German-led bloc and the states of the Southern periphery — and the splits are about to become even more irreconcilable.

President of the European Commission Ursula von der Leyen holds a press conference at the European Commission on March 4, 2020 in Brussels, Belgium. Leon Neal / Getty

The coronavirus crisis is often compared to a natural disaster, or, as European Commission president Ursula von der Leyen called it, an “external shock” befalling our society from the outside. But pandemics don’t come from nowhere. They develop under social conditions and are associated with specific forms of metabolism between humans and nature. Indeed, this was true even of the first emergence of the current pandemic. Capitalist expansion and land grabbing have promoted the emergence of zoonoses, i.e., infectious diseases that, like SARS-CoV-2, are transmitted between animals and humans. The clearing of forests for industrial agriculture tears down natural barriers, as wild animals with previously unknown viruses are driven out of their habitats and come into contact with livestock and humans.

The comparison of the coronavirus with a natural disaster is even more misleading considering how it has spread globally. This is most obvious in the sense that China’s ever closer integration into the capitalist world market in recent decades facilitated the international transmission of the virus. But COVID-19 rapidly spread to — and through — Europe because austerity policy has severely damaged the health care systems in many countries, particularly in the aftermath of the Eurozone crisis, and because effective measures to contain the virus were taken far too late.

At the beginning of March — even as the EU backed Greece in suspending the Geneva Convention on Refugees in that country’s attempt to seal off its external borders — the European Commission vehemently opposed border closures within the Schengen area (covering most of the continental EU) such as could have contained COVID-19. Apparently, safeguarding the four freedoms (free movement of persons, goods, services, and capital) — the symbolic cornerstones of the neoliberal European single-market project — was seen as more important than a robust containment of the looming pandemic by reducing cross-border travel.

Moreover, complicating the “natural disaster” analogy, the economic disasters resulting from this crisis can hardly be attributed solely to the virus and the measures to contain it. Rather, the pandemic — like the bursting of the subprime mortgage bubble on the US real estate and financial markets in 2007 — reveals existing vulnerabilities and crisis tendencies. The pandemic was rather more like the needle that burst the speculative bubbles on the stock markets at the beginning of March.

These bubbles had been building up against the background of an already weak productive capital accumulation, fueled by the global oversupply of liquidity, especially as a result of the historically unprecedented long-term interest rate cuts and the quantitative easing programs of the Federal Reserve and the European Central Bank (ECB). The US stock market in particular has been considered highly overvalued for years. Simultaneously, capital accumulation in industrial production was weak due to accumulated overcapacities, especially in the automotive sector, but also in the chemical and steel industries. In Germany, for instance, industry had been confronted with a decline in value added and a crisis in the exploitation of capital since 2018. Hence, the economic cycle that began after the global financial crisis in 2008 had already come to an end in 2019, at the latest.

Yet the corona crisis is fundamentally different from the post-2007 global financial and economic crisis. While the latter was triggered by the bursting of the subprime mortgage bubble in the United States and spread from the financial markets to the so-called real economy, the measures to contain the coronavirus in most European countries are bringing a large number of industries, in particular tourism, catering, aviation, and non-food trading, to an almost complete standstill.

This is compounded by a severe decline of production in many industrial sectors, especially as global production networks disintegrate. The collapse of these sectors sucks the rest of the economy into the maelstrom of crisis. Ensuing credit defaults and the price erosion on the bond and stock markets shake up the already fragile banking and financial system in Europe. The default of leveraged loans and collateralized loan obligations, i.e., securitized loans to highly indebted companies, will aggravate this shock.

Despite these differences, this crisis — just like the global financial and economic crisis after 2007 — is likely to be further exacerbated by the architecture of the European Economic and Monetary Union (EMU). This time, however, the impeding “Eurozone crisis 2.0” could be much deeper, harder, and more life-threatening to the EMU than the last crisis. There are at least three indications of this.

First, the Eurozone crisis from 2008 to 2012 has never been fully overcome, despite official claims to the contrary. Moreover, the fundamental contradictions or “construction errors” of the EMU have not been eliminated, despite eight years of discussions over how to reform the EMU to make it more stable. Finally, this is even more of a problem in that the focal point of this crisis is not a relatively small, peripheral country like Greece, but Italy — the nation that has in recent years become a condensation of the EMU’s wider contradictions.

The Smoldering Eurozone Crisis

Contrary to the European institutions’ official announcements, the last Eurozone crisis was never completely overcome. Although current account imbalances declined as a result of austerity policy, economic development remained weak after the devastating crisis years, especially in the southern European member states.

Greece’s GDP last year was only at 2002 levels, while Spain, Portugal, Italy, and even France have not yet been able to reach their pre-crisis economic levels. Accordingly, unemployment remained high, especially among young people. Average real wages stagnated or fell, as in Spain or Italy, social inequality increased, and public debt surged. Greece alone is burdened by a colossal debt of 180 percent of GDP, despite the debt restructuring in 2012.

The Eurozone crisis thus continued to seethe underneath the surface — but was concealed by ECB policies. Since then-ECB president Mario Draghi’s famous promise to “do whatever it takes” to save the euro in 2012, the ECB has been successful in bringing down the risk premiums for Southern European government bonds with its giant bond purchase program, thus ending the acute phase of the Eurozone crisis.

This did not, however, address the underlying crisis tendencies, but only suppressed them temporarily. Risk premiums for government bonds of Southern European countries have continued to go up and down over the past years, and with the outbreak of the SARS-CoV-2 virus in Europe, they shot up again, bringing Southern European countries under massive pressure on the financial markets once again.

Blocked Eurozone Reform

The corona crisis therefore lays bare the EU’s historic failure. The European elites let the past ten years pass without correcting the fundamental contradictions and constructional flaws of the EMU. Broadly speaking, these arise from two particular features of EMU architecture. First, the ECB’s supranational monetary policy is not matched by effective balancing and risk-sharing mechanisms, i.e., instruments that counteract the development of imbalances between countries and regions in the Eurozone.

Second, because of the so-called monetary financing prohibition, the ECB, unlike other central banks, may not act directly as lender of last resort vis-à-vis the euro countries, i.e., as a central bank with the unlimited capacity to buy up government bonds in the event of a crisis. As a result, Eurozone member states can become insolvent in principle, making them vulnerable to speculative attacks on the financial markets and debt crises.

These flaws and contradictions in the EMU architecture became apparent in the financial and economic crisis after 2007, and potential remedies have been intensively discussed by both the European institutions and European heads of state and government. Since 2012, these discussions revolved around the introduction and expansion of mechanisms for risk-sharing and convergence between the member states, including in particular the demand for common government bonds issued by the euro countries (so-called Eurobonds), the creation of the post of a European finance minister together with an extensive Eurozone budget to promote convergence and to compensate for “asymmetric shocks,” and the demand for a common European deposit guarantee in the Eurozone.

To be sure, these proposals — raised mainly by France and Southern European governments, but also supported by trade unions in Germany — would not challenge the fundamentally crisis-ridden character of capitalist accumulation as such. What they could achieve, though, is to ensure that the contradictions of the EMU will not once again become the catalyst of a deeper crisis in Europe. Nonetheless, these proposals have encountered fierce resistance by the Northern bloc in the Eurozone centered around Germany, also including the Netherlands, Austria, and Finland.

This regional split in the EMU reform discussion is conventionally explained by highlighting the rich countries’ reluctance to establish a “transfer union,” i.e., redistribution from the rich North to the poorer South of the Eurozone. But this is only part of the picture, particularly as France is one of the main net contributors to the EU. While Germany but also other Northern and Eastern European countries integrated into the “central European manufacturing core” have redirected their traditionally strong export orientation toward the emerging markets since the onset of the Eurozone crisis, France has remained closely linked to the Southern member states. This has made the French power bloc highly dependent on the economic development there, and interested in stimulating it as much as possible.

By contrast, although the German power bloc relies on the euro as a key element in its world-market-oriented export strategy and thus on the preservation of the EMU, it seeks to keep the costs for its stabilization and defense to a minimum — and to outsource them, as far as possible, to the European periphery. For this reason, Germany, advocating a “stability union” instead of a fiscal or transfer union, insisted on imposing austerity policy on southern Europe, which not only caused massive damage to social infrastructure such as health-care systems but has also considerably weakened economic development in recent years.

This situation is aggravated by the fact that the financial markets remained largely unregulated, even after the last financial crisis. To make things even worse, the securitization of loans, which played a major role in the last crisis, was revived by the Commission within the framework of the capital markets union, and new financial market risks were created with the introduction of so-called STS securitizations. A European financial transaction tax is also missing until today.

At the same time, the European Banking Union remained unfinished due to German resistance. Thus, mechanisms such as a European deposit guarantee scheme, a regulation of the shadow banking system, as well as a common “backstop” for bank resolution are still lacking, i.e., precisely those mechanisms that would be of central importance now, as there are still non-performing loans in the amount of €786 billion in the balance sheets of European banks (ECB 2020). The corona crisis thus not only hits a fragile monetary union, but also a still unstable and insufficiently regulated European financial system.

Italy, the Epicenter of the Eurozone Crisis 2.0

As if this was not enough, the spread of the coronavirus has so far been particularly dramatic in Italy — the country that has become the point of condensation of the contradictions of the EMU for several years now. Already before the last Eurozone crisis, Italian industry came under massive pressure in the EMU as, lacking a currency of its own, it could no longer maintain its price competitiveness through devaluation. This is particularly the case as important parts of Italy’s manufacturing sector are specialized on consumer goods production such as clothing, shoes, leather goods, and furniture, which is especially sensitive to price competition from peripheral, newly industrializing countries.

As a result, manufacturing dropped from 19.9 percent of GDP in 1999, the year the euro was introduced, to just 15.2 percent ten years later, and almost 1 million jobs were lost in the manufacturing sector between 2001 and 2011 (from 4.8 million down to almost 3.9 million). Industrial decline was further intensified by the crisis and resulted in the enduring economic stagnation of the past decade, turning Italy from an above-average industrialized power to a below-average one, and reducing per capita GDP (PPP) from €1,000 above the Eurozone average to €4,000 below it in 2019.

GDP is currently at 2006 levels, and in the fourth quarter of 2019, the Italian economy even shrank by 0.3 percent — indeed, Italy would have slid into recession even without the coronavirus pandemic. These economic crisis tendencies have been increasingly amalgamated with political crisis tendencies, particularly the erosion of the traditional party system and the rise of the Lega and the Five Star Movement.

At the same time, Italy’s public debt — having surpassed the 100 percent of GDP threshold already in the early 1990s as a result of the crisis of the European Monetary System (EMS) — soared to over 150 percent of GDP during the Eurozone crisis, making it one of the highest in the Eurozone, second only to Greece. The banking and financial system is enormously fragile.

At the beginning of the corona crisis, Italian banks had almost €350 billion of non-performing toxic loans in their balance sheets, which corresponds to about 7 percent of total liabilities. Business bankruptcies as a result of quarantine measures could therefore trigger a cascade of bank insolvencies. Considering the small size of the European bank resolution fund, it is most likely the Italian state that will step in to bail out banks, especially as there is still no backstop to the European resolution fund. This could once again result in a devastating doom loop between banking crisis and public debt crisis, similar to the last Eurozone crisis. This time, however, it could engulf Italy, the third largest economy in the Eurozone, and with it the monetary union as a whole into the abyss.

Contradictions of Crisis Management  

As early as mid-March, then, the ECB was forced to stand up to the rapid rise in risk premiums on Italian government bonds with an unprecedented bond purchase program, the Pandemic Emergency Purchase Program (PEPP), worth €750 billion, in an attempt to renew Draghi’s promise of “whatever it takes.” Already, this intervention, however, led to fierce conflicts between Northern and Southern member states within the ECB’s Governing Council.

Due to the massive volume of the PEPP, the ECB could soon hold more than a third of the total government bonds of some countries, which would give it a politically delicate blocking minority on the issue of possible debt restructuring. In view of the dramatic development of the crisis, it is also unclear how long the ECB will succeed in pushing down risk premiums on Italian and other Southern European government bonds with its bond programs. After risk premiums on Italian bonds declined by the end of March, they have continued to climb again in April.

This has put pressure on the EU finance ministers to agree on measures to stabilize the EMU in face of an impending second Eurozone crisis, bringing fierce confrontations between the Northern and the Southern bloc to a head. First, Italy, Spain, and France are calling for euro bonds, whether limited in time (corona bonds) or not (euro bonds), to reduce borrowing costs and increase debt sustainability in the South, while Germany, the Netherlands, Austria, and Finland continue to reject them.

Second, the Northern and Southern bloc clashed over the question of whether credit from the European rescue scheme active in the last Eurozone crisis, the ESM, should come with the same conditionalities (and stigma) attached to it as in the past. This would imply obligations to implement neoliberal structural reforms such as reducing pensions and social benefits as well as “flexibilizing” the labor market by weakening labor rights and unions in exchange for rescue loans.

Along these lines, the Northern bloc insists that rescue loans should exclusively support additional spending to tackle the corona crisis and not to alleviate existing debt. The Dutch finance minister, Wopke Hoekstra, even went as far as to suggest that the countries worst hit by the pandemic deserved little solidarity as they had failed to build up the financial position to combat the crisis over the past years — effectively raising the middle finger to Italy and Spain.

Ultimately, then, the Northern bloc effectively killed the coronabond initiative during the standoff at the Eurogroup summit of April 7–9 — at least for now. Instead, the Eurogroup agreed on ESM credit lines in the volume of €240 billion, a €25 billion European Investment Bank (EIB) lending facility (credit guarantees), and a €100 billion temporary credit program to support national unemployment systems by the European Commission (SURE). The conditionality for ESM credits is supposed to be weak, but “standardized terms” will be agreed upon by the ESM governing bodies, which suggests that the conflict over conditionality is merely relegated into the ESM. Besides these tangible agreements, a “Recovery Fund” based on “innovative financial instruments” (read, coronabonds) is mentioned, but the momentum for such mutual debt instruments might already be fading.

At least so far, then, the German power bloc was successful in keeping alive and even strengthening the ESM — the central enforcement vehicle of austerity policy and the main political project of the German finance ministry in the EMU reform debate — and at maintaining conditionality for ESM credits, at least in principle. What is also certain, however, is that this agreement is anything but sufficient to avert an impending Italian state bankruptcy and a second Eurozone crisis.

After the April 7–9 summit, Italian prime minister Giuseppe Conte has rejected ESM credits in an attempt to secure his political survival from the resurgence of Matteo Salvini’s Lega. Even if his government accepted them, the current capacity of the ESM will probably not be enough, considering the sheer scale of the crisis. At the same time, tensions within the German power bloc are also increasing, with the main employer-financed economic think tank, the Institute of Economic Research, and even some prominent members of the conservative CDU, now supporting at least temporary coronabonds to prevent a further disruption of the EMU.

Dangers and Opportunities

We are therefore facing a highly contingent historical situation, making it difficult for the Left in Europe to prepare for future battles to be fought. It is not unthinkable that the Eurozone is heading for its breakup, resulting in far-reaching processes of economic renationalization. An Italian bank crisis could push risk premiums up again, leading to speculative attacks against Italy on the financial markets. In a second step, these attacks might also turn against Spain, Portugal, and Greece, particularly as tourism — one of, if not the most, important economic sectors in these countries — will lie idle much longer than other parts of the economy in Europe.

At some point, the ECB could fail to further suppress the speculative dynamics as tensions in the ECB Governing Council escalate over the unlimited expansion of bond purchases. Eventually, this dynamic will lead Italy into insolvency, causing the Eurozone to break up or at least to shrink to a core or “trunk” Eurozone composed of the Northern European bloc, possibly including France. This is possible but unlikely, given the enormous importance of the euro for world-market-oriented capital in Germany and for the geopolitical role of the EU as a whole.

Much more likely in our view is makeshift stabilization of the Eurozone now, and a full-blown neoliberal backlash afterward. The heads of state and government agree to ramp up extensive credit lines within the ESM and emergency loans from the European Investment Bank (EIB), and possibly even introduce some form of coronabonds limited in time and scope, issued via the ESM. However, unlike the initial credit tranches agreed on in mid-April, we expect these support mechanisms to be increasingly tied to strict conditionality, i.e., the implementation of structural reforms.

The Northern bloc led by Germany might even push through a shift of budgetary surveillance competences from the European Commission to the ESM in return for ESM-based coronabonds — a step that has been considered by the German Ministry of Finance due to the “politicized” budgetary surveillance procedures of the European Commission for some time now. Nonetheless, the management of the Eurozone crisis 2.0 results in fierce conflicts in the German power bloc and a renewed strengthening of the far-right Alternative für Deutschland as the extension of the ESM and common European bonds have been red lines for conservatives in Germany in the past.

This is why Germany, in order to bridge these cracks in the power bloc, together with other Northern European countries, is likely to insist that the European fiscal rules are not only reinstated as soon as possible after their current suspension, but also enforced even more rigorously through the new powers of the ESM. The sharp rise in national debt throughout Europe will justify drastic austerity policy cuts with once again devastating social consequences. The modest achievements in the area of climate politics over the past few years (phasing out coal, fleet emission targets) are being protracted and undermined under the pretext that the economy must be restarted at all costs and as quickly as possible.

But the looming Eurozone crisis might also turn into an opportunity for a post-neoliberal policy of social infrastructures and socio-ecological transformation of the Left. The corona crisis has already ingrained into collective consciousness just how important public health care and other critical, foundational social infrastructures are. This is a tremendously strong experience and a solid basis to build broad social alliances against austerity cuts and for a foundational economic renewal. The strategy against a new onslaught of austerity could be impressively simply: individual countries, supported by progressive alliances in the other member states, deliberately ignore the European fiscal rules, performing “strategic disobedience” even after they have been reinstated, thus gradually undermining and ultimately abandoning them.

To be sure, public budgets would then be consolidated through increasing public revenues, for example by introducing or expanding property taxes, securing and successively expanding the fiscal space for a renewal of foundational social infrastructures. At the same time, corporate aid schemes and nationalizations already underway right now should not only be linked to climate protection requirements to rebuild and transform production structures in a socio-ecological way, but also leveled to democratize the economy through public participation. Even the reliance on the world market, especially in such critical areas as the supply of medical goods, is no longer beyond dispute, bringing a balanced, need-oriented re-regionalization of production in Europe back into the realm of the imaginable.