Over the past couple weeks, the hopes of the euro zone have been pinned on two Marios – Mario Draghi, the newly installed president of the European Central Bank, and Mario Monti, the newly installed Prime Minister of Italy. Both have been handed key positions at a crucial time. One of them, Draghi, has taken charge of the one euro zone institution with the ability to react quickly and intervene positively to combat the spiraling debt crisis. The other, Monti, has vowed to reform the debt-crisis nation that poses the biggest threat to the future of the monetary union and the stability of the global economy. And fortunately, both of these men have won themselves the nickname of “Super Mario,” after the mustached video-game hero, for their superior record of accomplishment. The hope in the euro zone is that these two talented men can use their powers to rebuild investor confidence and prevent the debt crisis from eating further into the core of Europe.
Are these hopes well placed? Taking nothing away from the abilities of either man, I believe it will be difficult for them to live up to the high expectations placed upon them. The fact that so much attention has been lavished on only two people in a very complex euro-zone governance structure also tells us something much greater about the state of the monetary union today—something that doesn’t boost optimism about the euro’s future.
Let’s take a look at “Super Mario” Monti first. Monti is supposed to be an Italian version of the Dutch kid who stuck his finger in a hole in a dike and averted a flood. By pressing aggressively with economic reform in Italy, Monti is tasked with stopping the debt crisis at the Italian border and preventing it from flooding the core of Europe (more than it already has). Monti, then, is considered the euro zone’s last line of defense – and for good reason. The monetary union can absorb the debt crises in Greece, Ireland, Portugal and perhaps even Spain, but if Italy, the zone’s third-largest economy, needs some sort of bailout, we’re potentially looking at the dam caving in on the euro.
Can Monti save the day? He’s only been in office for a few days, so we shouldn’t judge him at this point. And he’s saying all of the right things, about both short-term fiscal reform and long-term structural reform to get the Italian economy growing again. Yet, in my opinion, he is in an impossible position. Sure, he can probably cut down the budget in the immediate term and have a quick impact on Italy’s financial position. Perhaps such a step, combined with long-term measures to improve labor flexibility and productivity, would be enough to restore investor confidence in Italy. Yet at the same time, the sort of reform Monti needs to implement could take years to have any visible effect. Capital Economics figures that even with a substantial reform program, Italy would require two decades to bring its government debt level down to a more sustainable 100% of GDP from 120% today. Pro-growth reforms would take at least several years to show up in economic statistics. The problem here is that investors are not in such a patient mood. They’re panicked, Italian bond yields have been soaring, and I fear reversing the situation will take far more rapid change than Monti can achieve. And even if Monti intends on being the Super Mario to quell the crisis, he is not a dictator – he will still have to get his reforms passed through a parliament that has been reluctant to endorse real change. That means a lot of political bickering and maneuvering will likely slow the reform process. Rather than the Dutch boy, then, Monti may be more like the guy who stood on the shore and tried to stop the tide from coming in.
So what about the other “Super Mario,” Draghi? The leaders of the euro zone know full well that Mario Monti can’t fix Italy in a day, so they’re looking to Mario Draghi to help out in the short term. Draghi has been under pressure from some politicians in Europe to step in and ease the debt crisis with a giant bond-buying program. The idea here is that if the ECB uses its muscle to intervene heavily in capital markets, the bank can suppress borrowing costs for Italy and Spain and give their new governments more time to reform. In other words, some in Europe want the ECB to become the “lender of last resort” for the troubled governments of the euro zone. There are some who see ECB intervention as the only way right now to save the monetary union from collapse. Here’s HSBC chief economist Stephen King:
At this stage, there is only one way of stabilising this crisis. The ECB has to expand its balance sheet. It has to become the lender of last resort on a much larger scale and, when required, print money…The ECB has to find a way to put all of its understandable reservations to one side and bite the bullet. There are now insufficient private sector creditors to keep Italy solvent and there are too few taxpayers prepared to stump up the necessary funds…Put all talk of Treaty changes, austerity packages and new Italian Prime Ministers to one side: the ECB has to act now if the euro isn’t to collapse.
Draghi, though, has been resisting, and in my opinion, for good reasons. Though the ECB has been buying up bonds on a limited scale, he is worried that a massive program would undermine the credibility and independence of the central bank. He also feels that such a scheme is outside the bank’s mandate. Here’s what he said in a press conference earlier this month:
What makes you think that the ECB becoming the lender of last resort for governments is what is needed to keep the euro area together? No, I do not think that this is really within the remit of the ECB. The remit of the ECB is maintaining price stability over the medium term.
Perhaps you may not agree with Draghi’s limited notion of the role of Europe’s central bank, but it is hard to dismiss his reasoning. The ECB was never meant to be a bailout fund for the euro zone. Nor would ECB intervention be a true, long-term solution to the debt crisis. The ECB couldn’t buy bonds forever, funding Italy, Spain and the rest of the gang indefinitely. Because of that reality, I fear heavy ECB bond buying could send the wrong signal to markets – a sell signal, an opportunity to get rid of your sovereign debt holdings now before the gravy stops flowing. In the end, you have a compromised central bank saddled with assets of declining quality, possibly in need of being recapitalized by Europe’s governments. So by pressing the ECB to act, Europe’s politicians may just be leading the bank down a road to perdition – and possibly an expensive one for the euro zone’s taxpayers.
So we can’t expect the Marios to save the euro. The crisis has just gotten too big for any two men to resolve on their own. And that’s where we get to the real ugly part of this story. The reason why so much hope has been lavished on the two Marios is because the rest of Europe doesn’t want to do anything more to solve the debt crisis. Germany’s Angela Merkel, France’s Nicolas Sarkozy and the rest are counting on Monti and Draghi to solve the crisis for them, so they don’t have to make tough decisions on euro zone reform, or greater integration, or committing more national resources to stabilize the monetary union. They are turning to the Marios so they don’t have to turn to their voters and tell them more sacrifices are needed to rescue the euro.
We can see that in the reforms that have been discussed on a wider euro zone level in recent days. Yes, Merkel and Sarkozy are talking the right talk, about better euro zone governance and stronger coordination and control over national finances. Though the details aren’t quite clear, we can see the outlines of what is being discussed. They appear to favor a fiscal crackdown, enforced by more stringent rules and sanctions on rule-breakers. If that is the case, such a plan would have been a nice idea a decade ago, but now the crisis has moved well past such a strategy. By the time such new governance in the zone would have a real impact, the euro could well be gone. Notice how this talk of deeper integration is focused almost entirely on rules and regulations and not on debt consolidation, a bigger bailout fund, or anything that would require a greater commitment from the euro zone’s healthier economies.
The Marios, no matter how “Super” they may yet prove to be, can’t save the euro alone. The debt crisis is a euro zone problem that demands a euro zone solution. The problem is we never seem to get one.