The EU's Recovery Fund has taken on a sacral character out of all proportion to its macroeconomic significance. The weekend gathering of EU elites at France's Cercle des Economistes was one long celebration of this pandemic package.
I did not hear a single participant seriously question whether this clutter of measures - ostensibly worth €750 billion ($1.2 trillion) but stretched thinly until 2025 - will make any material difference given the scale of the COVID shock, or whether its structure will prevent the eurozone's north-south gap widening fatally as an asymmetric recovery takes hold.
That shock is immense. The International Monetary Fund has slashed its forecast for 2020 yet again to -12.2 per cent for France and -12.5 per cent for Italy and Spain even assuming a benign scenario and no second wave. They will claw back just half the lost ground in 2021.
Political effects will hit with a delay as job subsidies wind down. Gita Gopinath, the IMF's chief economist, drew up these figures after the outlines of the EU's Next Generation Recovery Plan were already known, so clearly she does not believe the "game-changer" rhetoric.
The Recovery Fund is certainly an institutional coup for the European Commission. The Berlaymont will suddenly be able to borrow large sums on the bond markets and will control the way the money is spent. But be careful: it is a one-off. It does not imply fiscal union or eurobonds, and is best understood as a German manoeuvre to head off such a constitutional revolution. A Hamilton moment it ain't.
Nevertheless, the permanent bureaucracy in Brussels will gain fresh levers of patronage and police powers. This matters in EU eschatology. But in immediate terms, it is neither a New Deal nor an authentic economic rebirth. Stripped of decoration, the pure fiscal component (grants) amounts to €100 billion a year for the whole EU, or 0.6 per cent of GDP annually. This will be spread around, after much horse-trading and with political strings attached, and will have almost nothing to do with the pandemic once the funds are actually disbursed.
I am worried that people are going to see the numbers in the short run and think things are just fine
Olivier Blanchard, former chief economist of the EU
The details so far suggest Poland, Hungary and the east bloc will be the biggest recipients per capita - to buy them off. Some of the money will go to French and German regions. Italy will receive a modest net transfer for four years but it will be barely noticeable when set against the greater drama of its debt dynamics, a ratio rocketing past 160 per cent of GDP even if all goes well.
Hence the growing talk of a debt restructuring conference once the crisis is over - akin to the post-War London Accord of 1953 - in order to haircut Italian and Club Med debt. Caveat creditor. No funds will arrive before next spring.
In the meantime, Italy must cover a budget deficit heading for 14 per cent of GDP this year. The Italian treasury must find an extra €120 billion to €150 billion to cover the shortfall up to December. Not even the European Central Bank can mop up this much debt so quickly without deviating promiscuously from its "capital key", and provoking fresh complaints at the German Constitutional Court. "Who is going to buy the paper?" asks Lorenzo Codogno from LC Macro.
Nor is the Recovery Fund agreed in any case. The "frugal five" (counting Finland) are playing for time. They may well block a deal at next week's EU summit and try to push talks into the autumn, hoping that a V-shaped recovery will by then have changed the political mood. "I don't think we need this crazy hurry," said Mark Rutte, the ultra-hawkish Dutch premier.
There may well be signs of such a recovery by then, but whether it is an illusion or the real thing depends whether you believe the monetarists (super-bullish) or the New Keynesian establishment (much less sanguine). It is a defining theoretical debate. "I am worried that people are going to see the numbers in the short run and think things are just fine," says Olivier Blanchard, former chief economist at the IMF and doyen of the global Keynesians.
He warns of a "truncated V" in Europe that stalls after regaining two-thirds of lost output, followed by a treacherous hiatus before a vaccine arrives. There are some hints of this already. German industrial orders did not roar back as expected in May. They are still down 31 per cent from the pre-COVID peak, and down 52 per cent for car manufacturing. The 15,000 job losses announced by Airbus are a foretaste of what may be coming.
Weak industrial orders matter more than surging retail sales as an indicator at this juncture. Pent-up demand has inflated purchases. Will spending hold up as job subsidies run down and unemployment bites? I doubt it. As for Holland's Rutte, his negotiating demands are draconian. There should be no fiscal transfers, just loans, and these must be rigorously controlled.
Any aid to Italy and Spain - or the east Europeans - must be conditional on "deep reforms to pensions, labour markets, judicial systems and taxation". His tone has caused predictable fury in Rome. He seems never to have progressed beyond the discredited morality tale of 2011-15, when the eurozone's banking crisis was misdiagnosed as a Club Med debt crisis, and when Italy was subjected to austerity overkill by EU commissars.
Chancellor Angela Merkel is now trying to persuade Italy's Giuseppe Conte to accept a "Troika-lite" regime, meaning a formal request to the EU bailout fund (ESM), along with pension reforms to placate the frugal five. This has put Conte in an excruciating position. His Five Star patrons know that annihilation will follow if they accept such conditions. If the EU is not careful, its pandemic plan will end up causing an Italian political crisis and therefore a debt solvency crisis, setting in motion the very events it most fears.