Wednesday, October 22, 2014
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The Super Marios Have Failed

“The underlying pace of monetary expansion continues to be subdued...The December 2012 Eurosystem staff macroeconomic projections for the euro area foresee annual real GDP growth in a range between -0.6% and -0.4% for 2012, between -0.9% and 0.3% for 2013 and between 0.2% and 2.2% for 2014. Compared with the September 2012 ECB staff macroeconomic projections, the ranges for 2012 and 2013 have been revised downwards.”
--ECB president Mario Draghi, Dec. 6th, 2012

Here’s a brain teaser. Look at the two Marios, Monti and Draghi. No one would deny that they are exceptionally intelligent and perceptive people. Any country or central bank would be happy to have either of them at the helm. They are both Ivy League-trained economists (Monti at Yale, and Draghi at MIT). Either of them can think rings around most European or American politicians. I have had the occasion to meet them both a few times, and they are very impressive.

And yet, they are both pursuing policies that can only end in disaster, not only for Italy, but for Europe. I can’t believe that I could possibly know anything about economics or monetary policy that they do not; that is a truism: they know everything. So how do we explain the reckless and suicidal policies that they are pursuing today? I can offer a political explanation for their behavior and a psychological one, but neither are adequate. Politically, neither has sufficient authority to reject deflationism and to embrace reflation. Psychologically, Italian technocrats like the two Marios labor under the northern prejudice about the Latins, that they are lazy and hopelessly corrupt. It is understandable that these incorruptible technocrats would like to prove that the Latins are not constitutionally inferior to the Protestants and can live with a hard currency. Those are reasons but not very persuasive ones.

It is hard to believe that they are fully conscious of the fact that the policies they are pursuing are wrong and that they are both guilty of misfeasance and nonfeasance. Somehow they have convinced themselves that austerity, deflation and depression are, in the long run, good for Italy and for the eurozone. After all, every northern country has gone through austerity at least once since 1980 and they have all emerged stronger and more competitive. Why shouldn’t the south? I have to assume that their thought-process is that starvation is painful in the short-run but beneficial in the long run. If so, then one must ask: how large must the pile of contrary evidence grow before they can admit error, or have they gotten in too deep to ever admit error? I can understand that it is hard to call off a war just as you are starting to lose.

I can appreciate Monti’s logic: he wasn’t installed by Europe into the Italian premiership in order to hijack the ECB or to exit the eurozone. He was installed to act as Europe’s governor-general in order to ensure that Brussels’ orders are carried out to the letter, and that the corrupt politicians are unable to steal Europe’s money. Monti never had a chance to successfully revolt, although he tried (without success) at the June summit.

Now Monti wants to quit, and who can blame him? An honest professor in Italian politics is like Mother Teresa in Vegas. But I must say that one can only conclude that Monti has failed due to timidity or sheer exasperation.

Europe’s only hope is for the struggling countries to unite and to confront Germany, the Bundesbank and the ECB head-on. Monti, Hollande and Rajoy (and the others) simply must demand that (1) the ECB target growth and not depression, and (2) that the ECB buys the bonds of the peripherals without conditions or limits. If they don’t do that, then eurozone growth will remain negative, fiscal revenues will stagnate, deficits will grow, and credit spreads will start to back up. Just because the ECB’s bogus announcement of chimeric bond-buying has temporarily convinced the markets that all will be OK, it can’t last. Another market convulsion is just around the corner.

Which brings us to Monti and his “friend” Jens Weidmann of the Bundesbank. Monti, like all central bankers, has placed a very high premium on “institutional credibility” and consensus-building, and an apparently low premium on successful policies. Yes, the ECB has a single mandate (price stability) that it is fulfilling extremely well, as Draghi keeps emphasizing. But does the ECB really have a mandate to recreate the Great Depression, to bankrupt the peripheral countries and to destroy the eurozone? Was that the intention of the treaty that Italy, Spain, Portugal and Ireland signed?

I can only conclude that both men are brilliant but weak. Monti is afraid of Merkel and Draghi is afraid of Weidmann: “We can’t alienate the Germans, Finns and Dutch!” Why not? What have they done for the eurozone lately besides enforcing starvation?

It is astounding to me that a central bank of the importance of the ECB can casually forecast a shrinking GDP, as if it were an exogenous variable, like bad weather. The ECB advertises its failure by its own forecasts. Apparently Draghi and Weidman are satisfied with a prediction of a real recession and zero to negative nominal growth. If my numbers are correct, Italy’s GDP today is 27 billion euros smaller in nominal terms than it was in 2007, industrial production is down 20%, and youth unemployment now stands at 26%. This is taken to mean that the bank’s policies are “on track”. They must serve a lot of Kool-Aid at the ECB snack bar.

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