The European Commission will try to avoid a death spiral by adopting Stability bonds, aka Eurobonds. This week will be crucial for Europe’s future. First, Greece. Then, Ireland and Portugal. Now, Italy and Spain. The European debt crisis is not over, but it seems there are no solutions. If the Eurobonds programme will not pass, Europe will face another turmoil, another chapter of this crisis. We talked about Italy, ECB and Eurozone challenges with Hugo Dixon, founder, Editor-in-Chief, and the Chairman at Reuters Breakingviews.
Eurozone is facing the worst crisis from WW2, according to German chancellor Angela Merkel. Is the worse over or not?
The worst is not remotely over. Banks and other investors are now beginning to doubt whether the euro will hang together. This fear could easily become a self-fulfilling prophecy. Even if the euro survives (which I think is still the most likely scenario), the euro zone is almost certainly heading into a bad recession. A credit crunch is virtually unavoidable, austerity is breeding austerity, and confidence is shot to bits.
According to market sentiment, one of the main Italian problem was Silvio Berlusconi. But it’s not all about Silvio. Do you think Monti could restore investor confidence in Italy?
Berlusconi was a big problem because he destroyed confidence in Italy. Rebuilding it won’t be easy. That’s partly because Berlusconi is still lurking around in the wings, threatening to pull the plug on the new government if he doesn’t like what it does. And it’s partly because the problem is now bigger than Italy. Contagion across the euro zone is now so rife that I doubt that Italy on its own can any longer save itself.
That said, the new Monti government does need to demonstrate rapidly to its euro partners as well as to the markets that it is acting responsibly. If it can deliver a positive shock — say by abolishing baby pensions and finding a way to cut the debt level via a wealth tax/accelerated privatisation — that would be hugely beneficial. But as I said, that still might not be enough.
Italy also needs to use this crisis as an opportunity for catharsis. Ordinary Italian people need to take responsibility for their actions. As Napolitano said, they need to reflect on how they contributed to the current mess. They also need to stop being so passive and contribute to building a better future. Italy last had an opportunity for catharsis in the early 1990s during Tangentopoli. The country wasted that chance. It would be criminal to do so again.
There’s a debate on ECB mandate. Do you expect ECB will be a lender of last resort?
Some sort of ECB/IMF support will probably be need to help Italy out of its crisis. Help is needed on two fronts: the state needs to get its borrowing costs down; and the banks need to be able to find ways of funding themselves on a more secure long-term basis. The ECB will probably be willing to do more with the banks, although it may want Rome to inject more capital into them too.
Helping the government will be harder because neither the ECB nor Germany wants the central bank to print money. At the same time, the EFSF hasn’t got its act together and the IMF hasn’t got enough money to help Italy. I suspect some solution will be found but not before there is more chaos in the markets and further economic damage. And there’s the ever present risk that a solution won’t be found.
Try to look forward: What structure for Europe and Eurozone in 2020?
There are broadly four scenarios
1. The euro breaks up entirely.
2. greece quits the euro but everybody else stays in.
3. The euro shrinks to a core of say 6-8 countries (italy would not be part of this group)
4. The euro stays with its current members and even expands
I think the euro zone will survive. But I’m not totally confident that it will. If it does survive in the long run, there are two main ways it could go.
A. The conventional wisdom is that monetary union will buttressed by political union. There are various ideas about how such political union would work. But the German idea seems to involve much closer monitoring of individual governments’ policies combined with tougher budget rules. In return, it’s possible that the different countries would in some form or fashion pool their debts by issuing euro bonds. I must say that I don’t find such a mega state very appealing. I dont believe that the European people are remotely ready for such a union.
B. A better model would be to let individual countries pursue their own policies but subject them to the discipline of market forces. This would include letting states that built up too much debt go bust – but to do so in a controlled fashion. There would also have to be a proper lender of last resort function via the ESM/ECB for countries and banks that were solvent but facing liquidity problems. And there would need to be proper banking regulation across the euro zone rather than the current patchwork quilt. Finally, there would need to be somewhat more streamlined decision-making within the euro zone, certainly in a crisis. But this would fall a long way short of full fiscal/political union.