The economic shock that governments have imposed on the world economy remains difficult to comprehend. Across the world, politicians and central banks have taken economic risks with scarcely any solid ground from which to judge what will ensue. But if the economic outcomes are unknown, some of the political problems are already becoming stark.
Most governments want to end manufacturing supply chains in pharmaceuticals, antibiotics and medical equipment, and revert to national production. This instinct is likely to spread to high-tech sectors, and it means taking away production from China. But whatever Covid-19 has done to Xi Jinping’s world-view, it will not have convinced the Chinese leadership to abandon its long-term pursuit of “the great rejuvenation of the Chinese nation”. Its concern will be how to prevent foreign manufacturing competition from disrupting its ambitions. For all the newfound strength of Chinese consumer demand since the 2008 crash, China still has much to lose. To negate the Made in China 2025 strategic plan will seem an intolerable sacrifice. It will be easy for the Chinese leadership to presume that Western economies cannot adapt quickly enough to renewing manufacturing competition or to higher prices. That may well prove wrong. But China’s political response to an external economic shock will accentuate the consequences of discarding the post-Cold War assumption that economic interdependence can underpin geopolitical order.
Then there is Taiwan. Many have rightly lauded its approach to Covid-19 and its attempts to make the World Health Organisation face earlier what was happening in China. There will likely now be increased pressure in the US Congress to recognise Taiwan as a sovereign state. But nothing that has happened in recent weeks will have changed the Chinese leadership’s view that Taiwan is an inalienable Chinese province.
China’s dollar debt problems could encourage a belief in Washington that China is dependent enough on the US to justify an aggressive confrontation with it. When the Federal Reserve established a repurchase agreement facility for foreign central banks without swap lines (where it directly provides dollar liquidity), it made it possible for Beijing to borrow dollars against China’s US Treasury bonds. But whether China’s corporate dollar debt can be stabilised within the Federal Reserve’s international lender-of-last-resort sphere while much of the rest of the US-China economic relationship comes further apart must be questionable. At the very least, it is liable to test severely the Federal Reserve’s post-2008 capacity for endless improvisation around the now 13-year-long problems in dollar credit markets.
The Federal Reserve has also indirectly entered the oil market wars. In deciding to purchase high-yield corporate bonds, it has effectively added the American shale sector to its list of responsibilities. This may have pushed the Saudis and Russians towards a temporary accommodation with shale producers, prompting unprecedented US-Saudi-Russian cooperation to slash production to try to put a floor on prices.
Yet this triumvirate is without geopolitical foundation, and the production cuts demanded from the smaller Opec Plus members have plunged Pemex, the Mexican state oil company, into a full debt crisis.
In Europe, the policy response has intensified risks around the eurozone. The Italian government has made clear that domestic politics prevents it from using the European Stability Mechanism as a direct line of credit, meaning European Central Bank (ECB) support is pretty much all Italy has left. But the ECB’s recent moves may well be insufficient to enable a more decisive Italian fiscal response to its immediate economic crisis or, in the medium term, to sustain its debt.
But the bid by Emmanuel Macron and southern European leaders to push the eurozone to mutualise future borrowing to rescue Italy from its debt burden – which could in worst-case scenarios head towards 200 per cent of GDP – has raised the political stakes for the EU too high. Until those advocating eurobonds have a politically plausible suggestion as to who decides on the taxes necessary to back common eurozone borrowing, they are peddling false hope. A coherent demand for common eurozone borrowing requires a eurozone executive and a eurozone parliament to decide and authorise eurozone taxes.
Making the central question “Are we together or are we not?”, as the French finance minister, Bruno Le Maire, has insisted, presumes a euro political union that does not exist. In hard political terms, the question is whether the eurozone can continue with a federal monetary policy, confederal fiscal policy, and national democratic legitimation. If the Italian crisis shows it cannot, there have to be remedies that establish a democratically grounded federal fiscal authority for the eurozone, while allowing the EU to remain a multi-currency confederation with a unitary single market.
The governments pressing for eurobonds – bonds jointly issued by eurozone states – are not offering those remedies; nor indeed could they unless they were confident they could deliver another EU treaty. Indeed, it is highly unlikely that Macron would accept what any eurozone-level fiscal authority would entail for French sovereignty. In making eurobonds a test of the EU’s will to exist, he invites a political reaction that would wreck, not save it.
Excessive economic fear will be destructive. But prudence in politics is not a luxury for relatively good times. When there is so little underlying political order, as there is today both geopolitically and in the eurozone, it is an imperative.
Helen Thompson is professor of political economy at Cambridge University
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This article appears in the 22 Apr 2020 issue of the New Statesman, The coronavirus timebomb