Overnight, Italy has replaced Greece as the poster child for the Eurozone crisis. While political will stood in the way of fixing Greece, Italy may be beyond fixing.
Nobel economist and NYT columnist Paul Krugman snarked, "This is the way the euro ends. Not with a bang but with bunga-bunga." But, as the main feature in his own paper notes, "In the end, it was not the sex scandals, the corruption trials against him or even a loss of popular consensus that appeared to end Mr. Berlusconi’s 17 years as a dominant figure in Italian political life. It was, instead, the pressure of the markets — which drove Italy’s borrowing costs to record highs — and the European Union, which could not risk his dragging down the euro and with it the world economy."
I’ve for some time been bemused that journalists and other informed observers are shocked as each new European country follows Greece in crisis. After all, the acronym PIGS has been around since the 1970s and PIIGS, adding Ireland, has been with us for years. It’s not only a useful mnemonic device, it’s a roadmap.
Nonetheless, the rapid implosion in Italy has taken almost everyone by surprise. The yields on 10-year Italian bonds has topped 7 percent overnight "the highest level since the adoption of the euro 10 years ago and close to levels that have required other euro zone countries to seek bailouts." Barclay’s Capital has proclaimed, "Italy is now mathematically beyond point of no return." Their analysts Jeff Meli, Jigar Patel, and Justin Luther conclude, "While reforms are necessary, in and of itself will not be enough to prevent crisis," adding, "Growth and austerity will not be enough to offset cost of debt." They explain, " on our estimates, yields above 5.5% is inflection point where game is over, with the danger being that high rates reinforce stability concerns, leading to higher rates, which sees a deeper conviction of a self sustaining credit event and eventual default."
The Telegraph’s international business editor, Ambrose Evans-Pritchard, under the horribly unfortunate headline "America and China must crush Germany into submission," declared, "You cannot allow the biggest bankruptcy in history to run its course – with calamitous domino implications – before all options have been exhausted." He envisions President Obama and Hu Jintao undertaking "joint telephone calls to Chancellor Angela Merkel more or less ordering her country to face up to the implications of the monetary union that Germany itself created and ran (badly)."
Krugman thinks what’s needed is "radical change in policy by the European Central Bank" and proclaims "that the ECB rate hike earlier this year will go down in history as a classic example of policy idiocy. We would probably still be in this mess even if the ECB hadn’t raised rates, but the sheer stupidity of obsessing over inflation when the euro was obviously at risk boggles the mind." He concludes, "I still find it hard to believe that the euro will fail; but it seems equally hard to believe that Europe will do what’s needed to avoid that failure."
The FT’s Martin Wolf points to NYU’s Nouriel Roubini for options and offers four, each less appealing than the last.
Mr Roubini discusses four options for addressing these stock and flow challenges simultaneously: first, restoration of growth and competitiveness through aggressive monetary easing, a weaker euro and stimulatory policies in the core, while the periphery undertakes austerity and reform; second, a deflationary adjustment in the periphery alone, together with structural reforms, to force down nominal wages; third, permanent financing by the core of an uncompetitive periphery; and, fourth, widespread debt restructuring and partial break-up of the eurozone. The first could achieve adjustment, without much default. The second would fail to achieve flow adjustment in time and so is likely to morph into the fourth. The third would avoid both stock and flow adjustment in the periphery, but threaten insolvency in the core. The fourth would simply be the end.
Alas, huge obstacles exist to all of these options. The first is the most likely to work economically, but is unacceptable to Germany. The second is politically acceptable to Germany (despite the bad effects on its economy), but would ultimately be unacceptable in the periphery. The third is politically unacceptable to Germany and is even likely to prove unacceptable in the periphery, too. The fourth is unacceptable to everybody, if only for now.
Almost all analysts point in the same direction: The European Central Bank.
Evans-Pritchard says Merkel must be made to acquiesce to "mobilizing the full-firepower of the ECB – with a pledge to change EU Treaty law and the bank’s mandate – and perhaps some form of quantum leap towards a fiscal and debt union." Krugman thinks what’s needed is "radical change in policy by the European Central Bank" and proclaims "that the ECB rate hike earlier this year will go down in history as a classic example of policy idiocy. We would probably still be in this mess even if the ECB hadn’t raised rates, but the sheer stupidity of obsessing over inflation when the euro was obviously at risk boggles the mind." The Barclay’s analysts urge, "We think ECB needs to step up to the plate, print and buy bonds" but concedes "at the moment ECB remains unwilling to be lender of last resort on the scale needed."
Alas, the competition for most optimistic analyst has no entrants.
Evans-Pritchard declares, "The EU Project has become both dangerous and insane." Krugman concludes, "I still find it hard to believe that the euro will fail; but it seems equally hard to believe that Europe will do what’s needed to avoid that failure." Wolf is even less cheery: "If policymakers had understood two decades ago what they know now, they would never have launched the single currency. Only fear of the consequences of a break-up is now keeping it together. The question is whether that will be enough. I suspect the answer is, no."
Financial analyst Thanos Vamvakidis offers the most pithy assessment: Italy is "too big to fail, too big to save."
James Joyner is managing editor of the Atlantic Council. Image based on graphic from Daily Mail.