Europe’s rescue fiasco leaves Italy defenceless
The six weeks allotted to save monetary union have expired. The G20 has come and gone, yet no workable firewall is in place as the drama engulfs Italy and threatens to light the fuse on the world’s third largest edifice of debt.
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.
Rentokil’s bug battle 07 Nov 2011
Goldman: euro could split apart 05 Nov 2011
Tough-talking Germany takes the eurozone to the brink of a break-up 05 Nov 2011
Why the latest eurozone bail-out is destined to fail within weeks 29 Oct 2011
China signals irritation as Europe stares into the financial abyss 22 Oct 2011
Putting an end to the euro would be better than yet another bail-out 15 Oct 2011
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.