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.” (Eurointelligence.com, 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.