Wednesday, July 11, 2012

The Monti-Merkel Double Act

A simpleton, or a con-man, might attempt to persuade the richer members of a club, like the Germans the Dutch and the Finns in the Euro-zone, to accept the mutualisation of European governments debt through the large scale issue of Eurobonds with joint and several responsibility of all members. For inevitably those richer members would end up paying for all. No other kind of Eurobonds would solve the euro crisis, whether project bonds or mini-Euro-bills on a small scale, or with pro-rata responsibility, or Eurobonds issued by any European agency other than the European Central Bank (that is statutorily prevented from issuing them) and which in view of the minute size of the EU budget would be necessarily treated as junk bonds.

A simpleton or a con-man, or perhaps a wrecker, someone knowingly making unacceptable suggestions thus providing an alibi for the refusal of more plausible, useful suggestions, such as raising the size of the European Stabilisation Mechanism, or re-balancing and reflating the German economy.

Why, then, have Mario Monti and Francois Hollande so insistently and persistently, indeed obsessively pressed for the issue of such Eurobonds, ignoring loud and clear, repeated refusals? That Hollande should do it should not surprise: he is a well-meaning socialist, and an ill-advised beginner with no previous experience in government. But why Monti, the shrewd economist and experienced former Eurocrat?

There is a rational explanation. By knowingly making an unacceptable demand, Mario Monti gave the German Chancellor a wonderful opportunity to take a spectacular stance: “Not in my lifetime!”. It is no accident that according to a poll conducted after the EU summit her popularity rating rose to the highest level recorded in the last three years.  The poll also confirmed strong support for her stance in the euro-zone debt crisis, showing that 66% of Germans were satisfied with her performance, an increase of eight percentage points from a month before and the highest reading since 2009 when she won a second term. “Some 58% of Germans believe Merkel's stance in the euro crisis is correct and decisive, although 85% of those polled also expect the crisis to get worse.” (, 7 July). 

At the same time, Angela Merkel obliged by making, in return, moderate, ambiguous and double-edged concessions, that involved support for the re-capitalisation of Spanish banks, the deployment of ESM funds to provide Monti’s “anti-spread shield” through the purchase of virtuous governments’ bonds (and not just to finance imbalances by rogue governments under troika’s supervision), as well as the Europe-wide monitoring of major banks with ECB involvement, a step construed as an anticipation of a banking Union. Francois Hollande got a modest investment injection of 120-130 bn euro, of which only 10 bn could be regarded as additional to already available resources. A win-win solution for all, then? Certainly enough for Mario Monti to return home to a hero’s welcome, portrayed on Facebook like the footballer Balotelli who on the same day scored the crucial winning goals against the German team. The threat of the Monti government crisis subsided. Italy’s 10 year bonds’ spread over German Bunds fell significantly though temporarily.

It is immaterial whether Merkel and Monti staged a concerted Double Act, or Merkel reacted predictably to Monti’s Eurobonds pressing, with Monti then demanding a modest reasonable concession which Merkel made more comfortably than otherwise might have been the case.

That Merkel’s concessions were moderate, ambiguous and double-edged it became clear very soon; indeed it took financial markets only 48 hours to have second thoughts about the deal. Partly, the devil is in the details, and the concessions were downsized when the details were specified.

The ESM was expected to inject equity directly into banks, breaking the link between banks and government debt, whereas it was clarified by officials that a national government guarantee would be retained; and the Karlsruhe Constitutional Court is taking its time to study the ESM and Fiscal Pact before taking a decision; and the ESM involvement will have to wait for new Europe-wide monitoring of banks to be established to the ECB satisfaction, probably not before 2013.

The size of the ESM remains what it was before, 500 bn euro of which 275 bn are already earmarked and committed to the support of Greece, Portugal, Ireland and Spain. The maximum liability that might be incurred by the Germans as a result of ESM operations therefore remains unchanged, in spite of the broadening of ESM responsibilities towards banks and holding down spreads of “virtuous” countries. We do not know yet what the spread ceiling will be; the ESM intervention will not be automatic but will require a specific request by a country, which might be deterred from making it by the stigma that will necessarily be attached to such a request. The ESM will buy government bonds through the ECB as its agent, thus to a Martian the process will be initially indistinguishable from the ECB acting as Lender of Last Resort to Governments; but any earthly investor will be aware that the ECB intervention will be limited at the very outset to the residual 225 bn funds uncommitted at present and, as pointed out cogently by Paul de Grauwe, will start selling his bonds of the governments involved long before those modest funds come to an end, thus triggering off the rise instead of the fall of the spread.

“Monti obtained the Anti-Spread Shield”. “Yes, and he was given a brand new Damocles’ sword in return” (a cartoon in Il Fatto Quotidiano of 10 July).  The so-called Anti-Spread Shield provides a mouthful of oxygen ("una boccata d’ossigeno", commented an Italian former Premier, or rather we should call it "una Bocconi d’ossigeno").  It is not a solution, but a way of “buying time for a solution without actually providing one” (Paul Collier, 10/07/2012). At a cost, of course: the probability of a crisis is reduced, at the cost of making the crisis all that much more serious if and when it occurs - not necessarily a superior trade-off.

At a Press Conference of 9 July in Rome, Monti was asked whether he regarded the current and unchanged size of the ESM as adequate. He answered that interventions could be effective even on a small scale, but that he “might be wrong”. So he might, just think  how the UK and Italy were kicked out of the European Monetary System by a couple of Hedge Funds in 1993.

Clearly the time has come now to forget and bury Eurobonds, even in the long term. To recognise that so-called structural reforms will have no positive effect on growth for at least the next five years; and that austerity has already gone too far and more austerity can only yield more recession, worsening debt/GDP ratios and spreads. That the ESM size needs increasing, the sooner the better, and/or be granted a banking licence so as to enable to ECB to legitimately lend to it and raise the scale of its operations. And that the time has come for Germany to end its rabid obsession with inflation and austerity, and raise wages and public and private expenditure reducing its external imbalance (surplus) and turning on its growth wheels.   


Alberto Chilosi said...

"A simpleton, or a con-man, might attempt to persuade the richer members of a club, like the Germans the Dutch and the Finns in the Euro-zone, to accept the mutualisation of European governments debt through the large scale issue of Eurobonds with joint and several responsibility of all members. For inevitably those richer members would end up paying for all. No other kind of Eurobonds would solve the euro crisis"
In reality the mutualisation would not solve the crisis either. The reason is that Germany's finances are not much better than those of the other European partners, with a Debt/Gdp ratio of more than 85% and with the LandesBanken in not much better shape than the Spanish Casas for analogous reasons (mixing up of banking with the interest of local politicians). At the moment Germany enjoys an influx of funds at very low rates of interest because of its hard won reputation, making it the least worse outside option. In case it were to join the other lesser reputable Eurozone countries, mutualizing their debts, the credit of the others would not improve but the credit of Germany would worsen dramatically, to no one advantage.
Moreover if the French and Italians are so keen to have the eurobonds they are free to do it on the basis of enhanced cooperation, together with Greece, Portugal and Spain, but one does not see why they should bother a reluctant Germany to do the same against its best interests.

Alberto Chilosi said...

"To recognise that so-called structural reforms will have no positive effect on growth for at least the next five years"

It is not so clear why. Owing to the constraints on the side of the public finances (essentialy due to the abolition of the stability pact in 2003/4 by Chirac and Schroeder, with the enthusiastic support of Tremonti and his creative accounts), the possibilities of playing Ponzi financing Keynesian policies of deficit spending seem very much constrained. Besides monetary policy (which is the exclusive domain of the ECB) the best hope lies in supply side policies reducing the rents of the have (privileges of many sorts,barriers to entry and competition, strongly protected employment, excessive pensions rights) and trying to improve efficieny and the lot of the have nots.

Alberto Chilosi said...

"austerity has already gone too far and more austerity can only yield more recession, worsening debt/GDP ratios and spreads"
If this is the case it means that by doing the contrary (a reflationary policy) GDP would increase more than the debt. If this is were the case Greece by now would have no difficulty to finance its debt, with no haircut, because its ratio of Debt to GDP would be minimal. When your problem it to have too much debt it is not really a good idea to increase your indebtedness, unless your creditors are ready to let you playing Ponzi with them. It has been the case with Italy before the crisis, but times have changed.

Carlo Clericetti said...

Quella della necessità della licenza bancaria all'Esm è l'ennesima cortina di fumo in un dibattito in cui nessuno - leader o tecnocrati - la racconta giusta. Dice infatti l’articolo 18, comma 1, dello statuto Bce che questa può “effettuare operazioni di credito con istituti creditizi ED ALTRI OPERATORI DEL MERCATO, erogando i prestiti sulla base di adeguate garanzie”. E Bce ha appena detto di considerare adeguati i titoli BBB (come quelli di Italia e Spagna). Non bisogna cambiare niente (al massimo le linee-guida Bce), basta volerlo fare.

Mario Nuti said...

Thanks, Alberto, for providing an additional case against Eurobonds and the mutualisation of debt.

Structural reforms mean different things to different people, and cover a multitude of sins. A reform is by definition a change for the better, but whether many proposed changes are for the better remains an open question. For example, why should the abolition of Art. 18 of the Statuto dei Lavoratori lead to higher employment and growth? Monti seem to think that reform should include the abolition of concertation, that in the past served us well precisely at times of crisis.

All the measures you mention are undoubtedly for the better, but are not being introduced on a large enough scale and fast enough. And if there is a War on Debt, as Monti declared yesterday, why not an immediate capital levy? A la guerre comme à la guerre…

I am not advocating reflationary policies, but less deflationary policies, which are not the same thing. Greece’s burden of debt escalated because of the austerity imposed by Europe. And Italy already has a sizable and growing primary surplus. And let’s cut the purchase of F-35, rather than hospital beds.

I am grateful to Carlo Clericetti for pointing out that the ECB is already entitled to lend to the ESM, undoubtedly one of the “other market operators”, on the strength of “adequate guarantees”; and that Italian and Spanish bonds are already considered as adequate guarantees; so that the problem is not one of entitlement but of policy willingness. Last December Mario Draghi spoke of credits to the ESM as an inappropriate escamotage; let's hope that he might think again.

Nicola Rubino said...

Professor, allow me to ask you something about the neverending question of the Eurobonds.
A couple of days ago, I was impressed by an article on the "Sole 24 ore", which showed how the italian unification brang with it the necessity of creating a new, unified national bond. At that time, the author of the articles states the 10 year interest rate to amount to 4.5% in the reign of the two sicilies, and to more than 6.5% for the Piemonte bonds (such as we could consider the reign of the two sicilies bonds as that times' benchmark). Now, my point is: Shouldn't the operation of merging the two bonds into a single one, after more than 150 years, be considered as a succesful one and act as a good and positive example for a potentially similar action here and now in Europe?

D. Mario Nuti said...

It is not sufficient to have a good precedent. You need to persuade the Germans, whose current "narrative" of the issue is constructed in terms of lazy cicadas trying to exploit hard working ants. "No solidarity without controls".

And German re-unification was expensive.

Barbie said...

Do you reckon Moody's downgrading of Italy yesterday was unjustified?

D. Mario Nuti said...

To some extent any downgrading can be self-fulfilling, and as such both right and unjustified at the same time. Moody's recent downgrading of Italy is no exception.

After the event, the downgrading was supported by the IMF downwards revision today of 2012 and 2013 growth for Italy and the whole Euro-area, and the expected accompanying rise of Italy's debt/GDP ratio (also because of the cost of its contributions to the ESM).

Partly Italy's downgrading is justified by political uncertainties, with the announced comeback by Berlusconi the scoundrel; the PD quarreling about gay marriages and stifling internal democracy, and the Party's n. 2 decreeing that voting for Berlusconi is better than voting for Grillo; and with Grillo poised to get second position in the elections and advocating leaving the euro; and neither Monti nor Napolitano standing for another term service.

Nicola Rubino said...

So, about that, one more question: How much do you think the situation would change by letting Europe have its own, fully independent, rating agency professor? Would that be enough to give European investors the impression that europe is keeping a good watch on itself and its financial system? Or is relying on agencies such as Moody's and Standard and Poor's still the right thing to do in Europe nowadays?

D. Mario Nuti said...

I do not feel that a public European agency would enjoy - rightly or wrongly - the same credibility of an allegedly independent private agency.

The best course would be - as recommended by the De Larosière Committee back in 2009 - reducing significantly over time the use of credit ratings in financial settlements (Recommendation 3 of the Committee's Report).

Unfortunately this Recommendation was ignored by European Authorities.

Runner said...

I am not clear: is Italy being protected by the ESM operating as Monti's anti-spread shield, and to what extent, or not?

D. Mario Nuti said...

The ESM is not yet operational. The German Constitutional Court asked the German President to postpone signing the Law until the Court had had the time to examine it carefully to assess whether it violates the German Constitution. The earliest the Court will decide is 12 September.

In the meantime, the EFSF is still operational, but its funds are inadequate to sustain a significant intervention by the ECB to hold down Italian spreads if need be. The new Italian Finance Minister, Grilli, has stated that Italy will not ask for the shield to be activated in the near future, but August is generally expected to be a "hot" month for speculation against the euro and in particular Italy.

Bob said...

So, who won, Monti or Merkel?

D. Mario Nuti said...

Neither. As Charles Wyplosz put it (, 30 July 2012) "the crisis was the only winner".

D. Mario Nuti said...

Correction on the above comment: 30 June, of course.

Meme said...

In Italy's case, would early elections say next October improve the spread or raise it to even worse levels?

D. Mario Nuti said...

Early elections might well reduce uncertainty about the after-Monti and reassure financial markets if the same policies are continued or improved upon. As long as elections are preceded by electoral reform - ending party nomination of candidates and, in the Senate, majority premia on a regional basis which may generate non-governability of that Chamber.

On the other end, the very prospect of Berlusconi returning to politics, whether as a candidate to the Premiership for the seventh time or, worse,to the Presidency might well be de-stabilising. (See "The last thing Italy needs", The Economist, 21-27 July). Not to mention the possible split of the Northern League or reconstruction of the alliance with Berlusconi's, the advance of Grillo's 5-Star Movement, and above all the uncertain alliances to be decided by PD, Vendols's SEL, Casini's UDC, Di Pietro's IdV, etc. etc. And new elections did not do Greece any good.

Markus said...

Se permette avrei una domanda OT: secondo lei perché in Italia non è nato un movimento come Occupy Wall Street, gli Indignados, il PPI tedesco?
Non crede che oltre alle analisi anche appassionate sarebbe necessaria una discussione su questo punto, visto che la realizzabilità di qualsiasi proposta in sostanza dipende in primo luogo dalla partecipazione dei cittadini che nonostante l'urgenza del momento sembrano disuniti e scoraggiati?

D. Mario Nuti said...

Why did Italy not generate a movement like Occupy Wall Street, Los Indignados, the German PPI? Ultimately - Markus says - the possibility of implementing any new proposal depends on the degree of participation of citizen, who in Italy seem to be dis-united and discouraged, in spite of all the urgency.

Italy has a popular/populist political movement, Beppe Grillo's 5-Star Movement, that at the moment is expected to obtain about a quarter of the votes in the next elections. I reckon that is very much the equivalent of the movements mentioned by Markus for other countries. Unfortunately such movements will not make much difference to the implementation of (still fairly vague) radical proposals.