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Ambrose Evans-Pritchard: Italy's insurgents enrage Germany and risk ECB payment freeze
By Ambrose Evans-Pritchard
The Telegraph, London
Thursday, May 17, 2018
https://www.telegraph.co.uk/business/2018/05/17/italys-insurgents-enrage...
The European Central Bank may be forced to sever credit lines to Italy in a drastic financial showdown if the country's insurgent coalition tears up EU spending rules and subverts the treaty foundations of the euro.
Professor Clemens Fuest, head of Germany's influential IFO Institute, said the EU authorities cannot stand idly by if the neo-anarchist Five Star Movement and anti-EU Lega nationalists press ahead with revolutionary policies and endanger the stability of monetary union.
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Professor Fuest warned that the ECB would have to cut off Target 2 credits to the Bank of Italy within the internal payments system, potentially bringing the crisis to a climactic head. "If they start to violate eurozone fiscal rules, the ECB will reluctantly have to act. It will be like the Greek crisis. Italy will have to introduce capital controls and will be forced out of the euro," he said.
"It would be a massive blow but I think the euro would survive with France and Germany, and Spain still in there. It would be a different euro," he said.
The German establishment has reacted with fury to a leaked plan by the Lega and the Five Star "Grillini" to overthrow the disciplinary architecture of the euro project, warning that it kills off any chance of German assent to shared debts or tentative fiscal union.
"The bottom line is that they are issuing almost an ultimatum. They are saying that either there are fundamental changes to the eurozone, with fiscal transfers for Italy, or they will leave the euro," he told The Daily Telegraph.
Professor Fuest said the original draft text prepared by the two radical parties exposed their ideological reflexes and fatally damaged trust, even if the final text is being toned down.
"It has confirmed people's worst fears and had a very bad impact in Germany. How can you have a shared deposit insurance (for banks) with a government like that in Italy? It is just unthinkable," he said.
"They are threatening to undermine the Fiscal Compact and the Stability Pact and the entire institutional basis of monetary union."
German economists have been stunned by radical demands for a cancellation of E250 billion (L220 billion) of Italian bonds held by the ECB. The clause has since been removed but the damage is done.
"Italy's policy is unmasked. They want others to finance their debt," said Lars Feld, one of Germany's "Five Wise Men" on the Council of Economic Experts.
"Why should there be any risk sharing in EMU if the new Italian government asks for a E250 billion haircut? It is time to ring-fence against Italian risk," he said on Twitter.
Whether the fall-out from "Italexit" really could be contained is an open question. Many think contagion would spin out of control.
Furthermore, it is the express intention of some Lega-Grillini hardliners to force Germany to leave the euro by making it unworkable. They would retaliate by issuing a parallel currency within the eurozone and sending troops into the Bank of Italy if necessary. This vastly complicates the picture.
Italy's Target 2 debt within the ECB's internal payments nexus has become a neuralgic subject. The liabilities topped E426 billionn in April -- 26 percent of GDP -- reflecting chronic capital outflows from the country. The worry is that they might spike to systemic levels in a crisis.
Willem Buiter, Citigroup's chief economist and a former UK rate-setter, says weaker EMU central banks are little more than currency boards. They can go bankrupt and are not "credible counterparties." He argues that the ECB may ultimately have to suspend funding lines to "irreparably insolvent" central banks in order to protect itself.
Hans-Werner Sinn, a celebrated economist at Munich University, said there is no mechanism for Germany to retrieve the vast sums that it has sunk into the eurozone, including the E923 billion of Target 2 credits owed to the Bundesbank. "We will never get the money back. It is already lost," he said.
Professor Sinn said the structure is equally unworkable for Europe's North and South, leaving both in a state of smouldering resentment. "There is no possible solution to this. The catastrophe is happening. This is going to lead to the destruction of Europe, to say it bluntly. It will also bring AfD (Right-wing populists) to power in Germany," he told The Daily Telegraph.
The Lega and Grillini were still arguing over the terms of the coalition deal on Thursday. There is no agreement yet on the choice of prime minister. Five Star intends to submit the coalition plan to an online vote. The deal may yet fall apart.
Italy's constitution gives president Sergio Mattarella de facto power to impose the premier and the finance minister. He can order the government to stay within agreed EU treaties. But these are largely untested waters in the Italian post-War republic.
If he pushes too hard, talks will collapse and lead to a fresh elections. Polls suggest that the insurgent parties would increase their votes. President Mattarella must pick his poison.
The volcanic developments in Italy doom Emmanuel Macron's hopes of a "grand bargain" for the eurozone. The French leader had been gambling that Germany might accept some steps towards economic union, with a eurozone budget and finance minister, if France delivered on economic reform.
It was already a hard sell. The Dutch-led "Hanseatic League" of Nordic states warned that they will not be dragged into "romantic" adventures, calling for strict budget rules. Each state must be responsible for its own debt. The Lega-Grillini démarche is the last straw.
Olaf Scholz, Germany's Social Democrat (SPD) finance minister, has warned that much of the Macron plan will never see the light of day. This week he rowed back further, suggesting that there will be no fiscal backstop for the Single Resolution Mechanism until deep into the 2020s. This eviscerates a key pillar of the EMU banking union.
It was wishful thinking to suppose that an SPD finance minister would deviate far from the "Ordoliberal" reign of Wolfgang Schauble. "Macron will not get anything from Germany. Scholz is exactly the same as Schauble," said Heiner Flassbeck, the former German economic state secretary.
"The German view is that they are right all the time and the only way to run the eurozone is for everybody to be like them," he said.
The resounding German "Nein" means the eurozone will remain unreformed and naked when the next global downturn arrives. Little has been done to avert a repetition of the "doom loop." Vulnerable banks and sovereign states can still drag each other down in a vicious spiral.
The situation is bleak. Almost a decade after the Lehman crisis, eurozone interest rates are still negative and quantitative easing has reached technical and political limits. The bloc is still in a Japanese "lowflation" trap. Debt levels are much higher.
Now intra-EMU politics are turning particularly toxic. The project will face an ordeal by fire when the economic cycle turns in earnest.
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