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What the $2 trillion coronavirus bailout is really going to cost

Americans will pay the price of the economic rescue package: Not in higher taxes to service the debt or higher inflation, but in a slide toward a boom-and-bust economy.

Economists tell us that there is no such thing as a free lunch — that you must always give up something of value to get something you value more.

But Americans may be getting something close to a free lunch in the $2 trillion economic rescue package, thanks to an accommodating Federal Reserve and a financial slight-of-hand known as “monetizing the debt.”

Here’s how.

To get the money promised to businesses, households, hospitals and local governments, the Treasury will have to borrow it over the coming months by selling IOUs of various durations to investors in the Treasury bond market.

But at the same time that the Treasury is selling trillions of dollars of these short-term notes and longer-term bonds, the Fed will be buying up a roughly equal amount from the Treasury market (though not necessarily the exact same IOUs), making good on its recent promise to provide whatever “liquidity” the economy needs to get through the pandemic.

And where will the Fed get these trillions of dollars? That’s easy. All it has to do is print as much money as it needs by increasing the balance that banks have “on reserve” at the Fed. That power to print money is engraved at the top of every bill in your wallet, in the words “Federal Reserve Note.”

In other words, one arm of the government will create $2 trillion out of thin air and then lend it to another government agency, which will turn around and give or lend it to households, businesses, hospitals and local governments.

The Fed rejects the idea that it is engaged in anything so sketchy as monetizing the national debt. It sees itself as merely fulfilling its mandate to promote full employment and price stability. And in good times and bad, the way the Fed accomplishes this mission is by buying and selling Treasury notes in the open market.

When you hear that the Fed has lowered interest rates by 0.25 percent, that’s how it does it. The only difference now is that it’s not just the usual short-term notes the Fed is buying, but the full range of Treasury instruments, and doing it in greater quantity than at any time in its history. It prefers to call this more aggressive bond buying “quantitative easing.”

Whatever you call it, however, it amounts to much the same thing. If the government can spend more than it takes in simply by creating money out of thin air, you might ask why it doesn’t do it all the time and spare us the endless hand-wringing over budget deficits and the national debt.

For most governments at most times, the simple answer is that it wouldn’t take very long before the price of everything would rise sharply, the value of its currency markets would fall, other countries would be reluctant to sell it goods and investors would refuse to buy its bonds.

Rather than a free lunch, debt monetization would be an extravagantly expensive repast paid in the form of hyperinflation, massive unemployment, an epidemic of bank and business failures. Just ask the folks in Argentina.

But for the United States at this moment of the pandemic, that risk is pretty low.

For starters, the United States has what has been called the “exorbitant privilege” of having the world’s reserve currency. That’s the currency held in large quantities by central banks around the world to use whenever they need to prop up their own currency on foreign exchange markets or pay the country’s international debt.

And because the dollar is the reserve currency, it is also used to price and pay for most globally traded commodities — oil and minerals but also illicit drugs and weapons.

Of course, those central banks and global traders don’t actually put dollars in a vault. Rather they use them to buy U.S. Treasury bonds, which pay interest and can be quickly turned back into dollars by selling them back in the Treasury market. And by buying all these bonds, they lower the rate at which the Treasury can borrow, allowing the United States to run large and persistent trade and budget deficits without suffering a dramatic fall in the value of its currency.

These days, however, it’s not just central banks that want to buy Treasury bonds. In times of crisis, global stock and bond investors also take refuge in Treasury bonds. Lucky for us, a surge in demand has come at precisely the moment the Treasury is about to issue trillions of new bonds for them to buy.

You can already see this dynamic playing out in global financial markets. The dollar has risen sharply, while interest rates on Treasury bonds have fallen to record lows. And central banks are now so desperate for dollars that the Fed has had to set up special programs to swap freshly printed dollars for other currencies.

The fundamental reason for all this — the reason the dollar is the world’s reserve currency and the United States remains a financial safe haven — is that our economy remains the world’s largest, most productive and most resilient. A lot of that has to do with the confidence the rest of the world has in our public institutions. Monetizing debt to stabilize an economy during a once-in-a-century pandemic is what you might expect from a competent government. Routinely monetizing debt because political leaders want to avoid making hard choices is not.

Some might worry that even if the new bonds are bought by the Fed, taxpayers will still be on the hook for the annual interest payments and for repaying the full $2 trillion when the bonds come due. Even that, however, is a shell game.

By law, any interest the Federal Reserve earns on its bonds is returned right back to the Treasury.

And if history is any guide, the $2 trillion will never be repaid. Instead, it will be forever “rolled over” as the Treasury issues $2 trillion in new bonds and notes to pay off the old ones. To actually pay down the debt, the federal government would have to run an annual budget surplus, which given the current state of our politics, isn’t likely.

It is possible that some day the bill for all this borrowing and spending will eventually become due. That could happen once the economy has recovered and the Fed decides having so much money still sloshing around the economy poses the risk of triggering inflation.

In that case, it might try to unwind its “quantitative easing” by selling those bonds into the Treasury market, effectively “unprinting” the money it created. That would not only raise the interest rates that the Treasury would have to pay to roll over its enormous debt, but could raise interest rates in the economy generally, slowing economic growth.

That’s exactly what happened on several occasions when the Fed sensed the economy had recovered from the Great Recessions and tried a bit of “quantitative tightening.” Each time, Wall Street threw a hissy fit and stock prices fell. And each time the Fed backed off, declaring that the inflation risk had passed.

Indeed, recent experience suggests that in a globalized economy characterized by slower growth and an excess of savings, the link between any country’s money supply and its inflation rate has been broken. The most compelling evidence comes from Japan, where the government has been monetizing debt like crazy for more than a decade but still worries more about deflation than inflation. And there’s Europe, where despite years of bond-buying by the central bank that generated negative interest rates, there is no inflation.

But recent experience also shows something else: While the Fed’s bond buying and money printing don’t always lead to general inflation, it does lead to excessive borrowing and inflation in asset prices — stocks, bonds, real estate and other investments. And when those bubbles finally burst, they result in significant losses of wealth, income, jobs and income security for millions of people who suffer the full impact from the busts without reaping much benefit from the booms.

In the end, the real cost of printing and spending trillions of dollars to rescue the economy is not likely to come in the form of higher taxes to pay debt service or higher inflation that reduces our standard of living. Instead, the price will be paid by having a boom-and-bust economy in which the level of indebtedness, the depth of the recession and the size of the government rescue increase with each cycle, until the world finally loses faith and we are forced to give up our exorbitant privilege, much as Britain did a century ago.

Nobody knows when that tipping point might be reached. But it is worth noting that the United States has already gone from being the world’s largest creditor to the world’s largest debtor, and our lead in that dubious category is widening by the day.

So as we enjoy the benefits of our $2 trillion free lunch, we might do well to remember the advice of a wise economist, Herb Stein, who famously reminded us that “if something can’t go on forever, it will stop.”

Furious at their plight being ignored and over resistance to coronabonds, Italians’ sense of betrayal deepens

A year ago Carlo Calenda ran in European parliamentary elections in Italy under the slogan “We are Europeans”, a rallying cry to defend his country’s place in the EU at a time of rising nationalism.

Now even Mr Calenda, a 46-year-old former minister and Italian permanent representative to the EU, is experiencing a crisis of faith in an idea he has spent a lifetime fighting for.

“This is an existential threat, I am not sure if we are going to make it,” he says. “You have to consider my party is one of the most pro-European parties in Italy and I now have members writing to me saying: ‘Why do we want to stay in the EU? It is useless.’”

As Italy faces its most severe crisis since the second world war, with more than 15,000 deaths from coronavirus and its economy on course to suffer the deepest recession in its modern history, there is a rising feeling among even its pro-European elite that the country is being abandoned by its neighbours.

“A massive, massive shift is happening in Italy. You have thousands of pro-Europeans moving to this position,” says Mr Calenda, who leads the recently formed liberal Action party.

Last month Sergio Mattarella, Italy’s softly-spoken 78-year-old president, and the man its establishment has relied on to safeguard its constitution and international alliances, warned the future of Europe was at stake if its institutions did not show solidarity with their country.

“I hope that everyone fully understands, before it is too late, the seriousness of the threat to Europe,” he said in an evening television address beamed into the homes of millions of Italians.

Many in Rome now feel that unless bold action is taken by northern European countries, they risk Italy turning its back on the European project forever.

There are already signs that Italian faith in the EU has been damaged. In a survey conducted last month by Tecnè, 67 per cent of respondents said they believed being part of the union was a disadvantage for their country, up from 47 per cent in November 2018.

Donald Tusk, the former European Council president, told the FT the situation today was much more worrying than during the euro crisis — both politically and economically.

Southern European expectations of a rapid demonstration of solidarity from the rest of the EU early in the pandemic were not met, even if the bloc has subsequently ramped up its assistance including financial aid and equipment.

“I hope everything can be fixed, but the loss of reputation is huge,” says Mr Tusk, who is now president of the European People’s party, the centre-right political alliance. “We must save Italy, Spain and the whole of Europe and not be afraid of extraordinary measures. This is a state of emergency.”

Mr Tusk says the EU’s assistance for Italy and other hard-hit countries is vastly more substantial than that from China and Russia, but he warns that “in politics perception can be more important than fact”.

In 2018 Italy became the first founding member to elect a government hostile to the EU, with Matteo Salvini, the anti-immigration League leader and then deputy prime minister of the coalition government, raging against “the Brussels bunker”.

The following year that government fell, and Mr Salvini was banished to opposition, giving pro-Europeans hope that the nationalist threat had faded. But many believe bitterness felt from events over the past month could permanently alter the country’s politics in Mr Salvini’s favour.

“There was a feeling before that the political system had marginalised the anti-EU forces,” says Lorenzo Pregliasco, a pollster at YouTrend. “Now if pro-European party activists and politicians are no longer so sure how they feel, imagine what the voters think.”

At the core of the argument is a bitter divide over the extent to which euro area countries should be pursuing a far more unified economic response to the crisis. Finance ministers will meet on Tuesday to attempt to agree a package of measures aimed at marshalling greater Europe-wide fiscal firepower.

Italy is among the member states that are pushing for the euro area to be far more ambitious by collectively selling bonds to help fund the massive economic rebuilding efforts that lie ahead.

The discussions mark just the latest iteration of a longstanding dispute over collective fiscal action that economists call debt mutualisation — and which many see as the biggest missing element of the single currency.

The EU does have a rescue fund called the European Stability Mechanism which countries can use. But despite assurances to the contrary from the ESM’s managing director, Klaus Regling, many Italians still fear lending from the institution would come with tough conditions attached and would stigmatise the country. It would feel to many that their country was being punished for a disaster that was outside of its control.

Roberto Gualtieri, Italy’s finance minister, has said that Italian gross domestic product is likely to fall by 6 per cent this year. Other economists believe this may be a conservative estimate. With the country entering the crisis with a debt-to-GDP ratio already at 136 per cent, there is a real threat that Italy’s debt reaches a level that brings into question its sustainability.

In March, with the virus already ripping through southern Europe, nine euro members led by France, Italy and Spain signed a joint letter pushing for so-called coronabonds — jointly issued debt backed by all euro countries including deep-pocketed Germany — to help pay for the recovery effort.

The depth of divisions over the topic was exposed at a tough EU leaders’ video conference call in late March in which the Italian prime minister Giuseppe Conte and his allies pushed hard for the door to be opened to coronabonds.

Mr Conte said the euro area’s bailout instruments had been developed for the last crisis and were ill-suited to the current symmetric shock hitting the entire continent. “What will we tell our citizens if Europe does not prove capable of a united, strong and cohesive reaction in the face of a symmetrical, unpredictable shock of this historical magnitude?” he asked.

Leaders eventually struck a compromise and issued a statement using vague language that effectively kicked deliberations in to Tuesday’s eurogroup meeting of finance ministers.

But the truce did not last long. Ursula von der Leyen, the European Commission president and a former German defence minister, appeared to use dismissive language in an interview, describing coronabonds as a slogan and appearing to express sympathy with Germany’s concerns about the idea.

The language provoked immediate rebukes from Mr Conte and Mr Gualtieri, forcing the commission to issue a late-night statement that vowed to leave open all options that are compatible with the EU treaty.

Ms Von der Leyen’s shifting positions reflected in part sharp divisions among her commissioners as well as the EU as a whole over the idea of coronabonds.

While the discussion over which financial instruments can be used to help Italy is technical, the tone of the debate has become emotionally charged in both southern Europe and in the north, where the Netherlands has sided with Germany in opposing coronabonds.

Mr Calenda last week took out a full-page advert in the German daily Frankfurter Allgemeine Zeitung, signed by himself and a number of leftwing mayors and governors from the regions worst-hit by the outbreak.

In it they attacked the Dutch position as “an example of a lack of ethics and solidarity”, called the country a tax haven and compared German reluctance to support joint European debt with the partial cancellation of Nazi war debts by European countries including Italy after the second world war.

“Germany could never have paid it,” the letter said. “Your place is with the Europe of institutions, of values of freedom and solidarity. Not following small national egoisms.”

“They shouldn’t be using such emotional arguments,” says Eckhardt Rehberg, a German MP in Chancellor Angela Merkel’s Christian Democratic Union. “Every country should ask itself whether it bears some responsibility for the situation it is in. Look at Italy’s health system. You cannot blame all your difficulties on Europe and Germany. As a German politician, I find that unfair.”

The current German-Italian tensions are part of a much longer dispute, stretching back to the eurozone sovereign debt crisis of 2010-12.

Even back then, many in southern Europe saw eurobonds as a potential solution. But Ms Merkel was always opposed, saying in 2012 that there would be no such instruments “as long as I live”. For the chancellor and her CDU party, the EU treaties were sacrosanct: and they expressly forbade the mutualisation of debt. The rule was clear: states cannot finance each other.

Yet in the eurozone more broadly, her reputation suffered. Southerners increasingly saw her as Europe’s great disciplinarian. Posters appeared in Greece showing her with a Hitler moustache. She was depicted as a witch, a dominatrix or a wicked stepmother, and accused of trying to subjugate the whole continent.

In Italy the hostility to her was fanned by the media empire of then prime minister Silvio Berlusconi. Records of bugged phone calls emerged in which he referred to the chancellor in extremely disparaging terms. In August 2012 the newspaper Il Giornale, owned by Mr Berlusconi’s brother, had a front-page picture of Ms Merkel raising her hand in a vaguely fascist salute, accompanied by an article claiming Italy was “no longer in Europe, it is in the Fourth Reich”.

The crisis has emboldened politicians on Italy’s right who sense the mood in the country is shifting against Brussels, as well as becoming more anti-German.

“The EU has gone from doing absolutely nothing to some trying to profit from the difficulties we are facing,” says Giorgia Meloni, leader of the far-right Brothers of Italy, which has made significant gains in opinion polls to become the second most popular rightwing party after Mr Salvini’s League.

“There are people who are trying to use the virus to speculate. There is a game to weaken Italy and buy its strategic assets,” she told the FT. “While we are counting our dead, they are counting the risk of losing interest on their bonds.”

Claudio Borghi, a League MP who has led a ferocious campaign against Italy accepting money from the ESM — arguing it would be tantamount to a surrender of sovereignty — this week posted an Italian Fascist era poster with a smiling German soldier extending his hand. The text reads “Germany is truly your friend”. Mr Borghi wrote: “Time goes on, but the tactics are always the same.”

Franziska Brantner, a German Green MP, says the Italians she has spoken to see themselves as “a laboratory for corona”, adding: “[They feel] Germany is just watching them and trying to learn from their experience. There is real bitterness among my pro-European friends in Italy. They’re saying what have we done to the Germans to make them treat us like this?”

Italy’s pro-Europeans are hoping that the mounting shock from the Covid-19 crisis will jolt recalcitrant northern European countries into making a large enough gesture of solidarity to repair the damage that has been done.

In recent days opponents of collective fiscal action have been on the defensive as the sheer scale of the economic slump has become clearer. In the Netherlands, the government of prime minister Mark Rutte last Wednesday proposed a solidarity fund worth €20bn, with cash transfers set to go straight to the coffers of Rome and Madrid to fund emergency medical spending.

His finance minister Wopke Hoekstra had been criticised in the south after he called on Brussels to investigate why some economies did not have fiscal buffers to see them through a crisis. Portugal’s prime minister António Costa called the remarks “repulsive”.

Mr Rutte’s proposal would only fill a small part of the gap given the vertiginous public finance challenges facing Italy and Spain, but the very fact that a country that has traditionally been a vociferous opponent of any fiscal transfers between euro area members should make such a suggestion is indicative of the changing public mood.

Bruno Le Maire, France’s finance minister, on Thursday laid out plans for an “exceptional and temporary” joint fund that would help countries kick-start their recoveries. This would issue bonds with the joint guarantee of all EU member states and be operated by the European Commission.

“Solidarity means to be able to pull together our resources to cope with the aftermath of the crisis,” he said. “Let’s avoid any ideological debates on eurobonds or coronabonds. There is one single political question: shall we stand together or not?”

For Mr Tusk there is now little time left for the EU’s richest nations to come forward with bold and positive initiatives and avoid instilling any sense of humiliation in countries that needed help. “People are suffering now — it is not a political game,” he says. “People have to feel that we are a real community and a real family in such a time.”

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