As of late Friday, the yield spread on Italian 10-year bonds over German Bunds was a post-EMU record of 458 basis points. This is dangerously close to the point where cascade-selling begins and matters spiral out of control.
The European Central Bank has so far bought time by holding a series of retreating lines but either it has reached its intervention limits after accumulating nearly €80bn of Italian debt, or it is holding fire to force Silvio Berlusconi to resign – if so, a foolish game.
The ECB’s hands are tied. A German veto and EU treaty constraints stop it intervening with overwhelming force as a genuine lender of last resort. The bank is itself at risk of massive over-extension without an EU treasury and single sovereign entity to back it up.
This lack of a back-stop guarantor is an unforgivable failing in the institutional structure of monetary union. As Berkeley professor Brad DeLong argues in a new paper, such “utter disregard for financial stability – much less for the welfare of the workers and businesses that make up the economy – is a radical departure from the central-banking tradition.”
The Bank of England was forced to jettison such reactionary nostrums in 1825 after the canal boom burst. It intervened in breach of its own mandate, over howls of protest by the hard-money men who warned that the “millennium of the paper-mongers would be at hand.” A near century of gentle deflation followed.
Mario Draghi toed the German line obediently in his debut as ECB chief last week – whatever this MIT-trained student of Robert Solow really thinks -- saying bond purchases could be justified only if “temporary”, "limited in amount", and undertaken to restore “monetary transmission". It would be “pointless” for the ECB to try to bring down yields for any length of time.
He could hardly say otherwise, especially as an Italian trying to seduce an army of German critics. German lawmakers had days earlier stipulated that the ECB must withdraw from its existing purchases of bonds as a condition for Bundestag approval of the revamped bail-out fund EFSF.
Yet Europe’s fiscal rescue machinery remains a fiction, a fund designed for Greece, Ireland, and Portugal that is now being stretched by every disreputable artifice of structured credit to shore up the whole EMU edifice on the cheap.
The market has already cast its verdict on plans to leverage the EFSF (version III) to €1 trillion as a “first loss” insurer of Italian and Spanish bonds, seeing at once that the scheme concentrates risks in lethal fashion for creditor states, dooms France’s AAA rating, and is likely to contaminate the core very fast.
The spreads on EFSF 5-year bonds have already tripled to 151 above German debt, leaving Japan and other early buyers nursing a big loss. The fund suffered a failed auction last week, cutting the issue from €5bn to €3bn on lack of demand.
Gary Jenkins from Evolution Securities said the “frightening” development is that the EFSF is itself being shut out of the capital markets. “If it continues to perform like that then the bailout fund might need a bail out,” he said.
Europe’s attempt to widen the creditor net by drawing in the world’s reserve states evoked near universal scorn in Cannes and a damning put-down by Brazil’s Dilma Rousseff. “I have not the slightest intention of contributing directly to the EFSF; if they are not willing to do it, why should I?”
Europe is resorting to such antics because its richer states – above all Germany -- still refuse to face up to the shattering implications of a currency that they themselves created, and ran destructively by flooding the vulnerable half of monetary union with cheap capital.
We can argue over details, but the necessary formula – if they wish to save EMU -- undoubtedly entails some form of eurobonds, debt-pooling, fiscal transfers, and of course the constitutional revolution that goes with all of this. That would at least buy them time, though I doubt that even fiscal union can ever bridge the North-South gap.
Italy’s travails have little to do with the parallel drama in Greece. This is not contagion in any meaningful sense. The country is suddenly under fire for the very simple reason that its economy is plunging back into deep recession, the predicable outcome of the EU’s 1930s fiscal and monetary contraction policies.
The implications of a eurozone double-dip are dreadful for Italy, already grappling with a chronic loss of 40pc in labour competitiveness against Germany and a 70pc collapse in foreign direct investment since 2007.
A report by Italian consultants REF Ricerche warns that Italy will remain trapped in recession through 2012 and 2013. The slump itself is causing fiscal slippage, not lack of budget rigour. “What is sapping the credibility of Italy’s public accounts over the medium term is lack of growth prospects,” it said.
Indeed, yet Angela Merkel and Nicolas Sarkozy continue to order Italy to undertake further fiscal belt-tightening into the accelerating downturn, even though it is one of the few countries in the OECD club with a primary budget surplus and even though its combined public and private debt is just 250pc of GDP – well below that of Holland, France, the UK, the US, or Japan. The EU policy dictates have become unhinged.
Mr Berlusconi invited much ridicule in Cannes by blurting out that the “restaurants are still full”. Less reported was his comment that the country’s exchange rate is misaligned within EMU and that this has been “paralysing for Italy”.
This is the elemental point. Italy is in the wrong currency. It should not be in Germany’s monetary union at all.
Italy’s crisis will deepen for fundamental reasons whether or not Mr Berlusconi’s disintegrating regime departs the scene. It is hard to see how an EU police mission -- disguised in International Monetary Fund clothing -- can achieve anything beyond inflaming Italian patriotic fervour.
Reform minister Robert Calderoli (Northern League) gave a hint of where this misguided euro-meddling will ultimately lead when he asked over the weekend whether “it is really worth the candle” staying in the European Union. “The Lisbon Treaty has a lot of bad aspects but one good point: you can withdraw from Europe.”
The Telegraph
No comments:
Post a Comment