A Dark Day for Europe
The decision to use joint EU debt issuance for Ukraine instead of Russian money is awful
The tug of war over Russia’s frozen reserves has been about two things. On the surface, it’s been about funding Ukraine and setting a precedent that - if you invade a country and murder innocent people - your financial assets are at risk of being seized. But, on a deeper level, it’s about something even more important, which is governance and moral direction within the EU.
The decision to issue joint EU debt to fund Ukraine is a disaster on both dimensions. It fails to set the critical precedent that Russia’s frozen reserves would be seized. That alone is terrible because it gives every tinpot dictator a blueprint for how to blackmail the EU. All you have to do is intimidate a small country like Belgium, which will then advocate on your behalf and protect your financial assets.
Furthermore, joint EU debt issuance makes fiscal dysfunction - already acute - even worse. It’s already the case that high-debt countries like Italy and Spain give no aid to Ukraine because they’ve run out of fiscal space. The chart above shows data from the Kiel Institute on financial, humanitarian and military aid to Ukraine on the vertical axis and nominal GDP in 2021 on the horizontal axis.
Joint EU debt issuance only perpetuates this problem. That’s because joint EU debt issuance is financial engineering that uses German fiscal space to create the illusion that everyone is helping when that isn’t true. This isn’t transparent and allows high-debt countries to keep kicking the can instead of fixing their public finances.
Beyond the immediate urgency of funding Ukraine, this episode is therefore about EU governance. Well-governed, low-debt countries in Northern Europe once again lost, while poorly-governed, high-debt countries in the South won. This is now the second time that a crisis has been abused by the high-debt South to push its own agenda of joint EU debt issuance. COVID was the first case. Ukraine is now the second. In the medium-term, this will only make the EU weaker, not stronger.
All this dysfunction radiates out from the ECB and its past actions to cap the yields of high-debt countries like Italy and Spain. If Germany were to reclaim its voice at the ECB and prohibit yield caps, this would right-size a country like Italy and reduce its influence at critical turning points like the past couple of days.
The only way to fix this governance issue is for Germany to replace its representatives at the ECB. Its current representatives are too willing to go along with yield caps and bond market support for high debt sovereigns, which weakens Germany’s negotiating position on issues like Russia’s frozen reserves. Underneath all this must be a credible threat for Germany to leave the Euro. This is the only way governance can be fixed, which is what’s needed to the EU to emerge as a credible player in global geopolitics.
On another note, I agree with the dysfunction you describe in EU finances. Still, as a Dutch person, I have to remind myself that countries like the Netherlands and Germany have benefited disproportionately from the single market and the euro. A fixed currency favored highly competitive export economies, while countries such as Italy and Spain lost the ability to adjust through devaluation and struggled to compete on equal terms. The result has been a long-term structural shift of industrial strengthn from south to north as seen in the large trade surpluses in the north of Europe. The EU monetary and economic framework amplified divergence rather than corecting them. I find it difficult to blame Spain and Italy for their inability to afford the war effort in the Ukraine.
I see your point. Yet, seizing money from a country you are not officially at war with, is in itself an act of war that would force Russia to respond. Avoiding this, trumps any other consideration. As a European, I am thankful that this path has been chosen. To me, it is the best of two bad choices.