30 September 2012

Simon Nixon: Berlin vs Rome - A tale of two visions

Spain is now the battleground for two competing visions of how the eurozone should operate, writes Nixon in his WSJ column. What happens next in the euro crisis depends largely on whether Berlin or Rome blinks first.

At the heart of the Spanish impasse lies a proxy battle between Germany and Italy over the response to the euro crisis. How this fundamental disagreement is resolved is likely to have a profound bearing on the future of the single currency area.

From Berlin's perspective, the answer is clear: the German government believes the OMT should only be a last resort; Spain should avoid asking for ECB support unless it becomes absolutely necessary. That's partly because Berlin would have to submit any Spanish request for aid to a potentially troublesome vote of the Bundestag; it's also partly because any government bond-buying by the ECB will further antagonise the Bundesbank, fanning an already heated dispute; and partly because Berlin fears that no sooner does Spain request aid than the market will turn its attention to other countries including Italy, fuelling the sense of crisis in the eurozone. If ECB support for Spain does become necessary, strict conditions will be required to ease the domestic political pressure on Berlin.

But viewed through Italian eyes, the situation looks very different. Rome believes the current wide spread between German and Italian bond yields is a gross distortion of economic reality... Rome believes that in economic terms, Italy's position is far closer to Germany than Spain. Instead, the economy is suffering from punitive interest costs and a withdrawal of foreign investor support that threatens to undermine its competitive position; Italian companies must borrow at much higher rates than competitors on the other side of the Alps, not through any fault of Italy's but because of short-comings in the construction of the eurozone. The country is paying a desperately high price for market fears over a euro break-up that stem from problems elsewhere. From Italy's perspective, the idea that economies in recession such as Spain and Italy should face rising borrowing costs while still-growing Germany enjoys ultra-low borrowing costs is a perversion of economic logic and shows a monetary system in disarray. In these circumstances, it believes the ECB has a duty to address failures in the monetary transmission system.

Indeed, the ECB, led by its Italian president Mario Draghi, has acknowledged its responsibility to fix the transmission mechanism by agreeing to create the OMT. But Rome believes the programme is badly flawed. The problem is the requirement that any country first needs to sign up to a eurozone rescue programme with conditions agreed with input from the International Monetary Fund. What this means is that Europe now has its bazooka, says one senior Italian policymaker, "but the ECB has put it in a safe and handed the key to the Bundestag". By effectively allowing the German parliament a veto over a monetary policy issue, the eurozone has raised doubts over whether this bazooka will ever really be effective. From Italy's perspective, it is therefore essential that Spain asks for aid, if only to prove the bazooka works.

But not everyone is convinced a Spanish request for aid would remove the pressure on Italy... As far as Rome is concerned, Italy—like Spain—has agreed to all the conditionality necessary to allow the ECB to fulfil its obligations as a central bank. It believes Berlin has a moral obligation not to stand in its way.

Full article

© Wall Street Journal