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Italy is now the frontline in the battle of the euro. Deputy Prime Minister Matteo Salvini is being propelled by a political tailwind that may, after the European Parliament elections in May, enhance his capacity to inflict serious damage on the European Union. What is both fascinating and disconcerting is that the xenophobia underpinning Salvini’s ever-increasing authority is being generated by the eurozone’s faulty architecture and the ensuing political blame game.
In its recent report on the economic imbalances afflicting each EU member state, the European Commission blames the Italian government for its failure to rein in debt, which, it says, results in tepid income growth. According to the Commission, the government’s reluctance to cut its budget deficit has spooked the bond markets, pushed interest rates up, and thus shrunk investment.
Salvini could not be more pleased. The report presents a splendid opportunity to blame the Commission itself for Italy’s travails, by arguing that it was actually the EU’s fiscal austerity policies which constricted growth, pushed the economy to the brink of a new recession, and led to the election of the populist government now dominated by Salvini. And, as if that were not enough, it was the Commission’s threats of penalizing Italy unless it imposed even greater austerity that unnerved bond traders and pushed interest rates up.
Italy’s tragedy is that the Commission and Salvini are both right – and also both wrong. It is correct that Salvini’s announcement that the government would rescind its promise to impose pre-agreed levels of austerity alarmed investors, made Italian debt less viable, and caused capital flight. But it is also correct that the Commission’s fiscal rules, were they to be implemented fully, would have caused a recession that would have made Italian debt less viable anyway. [...]
An intra-European comparison sheds additional light on the conundrum facing Italy and the eurozone. Spain and Italy have almost identical debt-to-GDP ratios (298.3% and 301%, respectively). So, why is everyone talking about Italy’s debt and not Spain’s? The answer is that 67% of Spain’s debt is private, whereas 64% of Italian debt is public.
In theory (and in law), the European Central Bank is not allowed to monetize any debt, public or private. In practice, however, the ECB has been able and willing to monetize private debt fully, simply by accepting as collateral private debt not even worth the paper it is printed on (for example, stressed Italian mortgages and Greek banks’ IOUs). In contrast, the ECB spent years refusing to buy government debt and, when it did, chose to exclude large swaths of bonds from its asset-purchase program. Put simply, any country whose debt was tilted toward the private sector, like Ireland and Spain, did much better than a country like Italy.
The eurozone’s defenders will reply that it is right that countries are penalized for allowing a high proportion of public debt. The ideological bias against anything public is not limited to the realm of utilities and railways. The credit rating agencies’ readiness to downgrade the bonds of any government that challenges conventional wisdom reinforces the neoliberal assumption that private debt is, by definition, less problematic than public debt.
But even free-market fundamentalists should realize how unsafe this assumption is. If the 2008 financial crisis taught us anything, it is that risks are too endogenous for comfort. Even if no corruption is involved, credit ratings and political choices are co-determined: If the ratings agencies get a whiff that the ECB will choke off Italian liquidity, they have a duty to their customers to downgrade Italian bonds. And if the ECB predicts that Italian bonds will be downgraded, its rules instruct it to diminish liquidity in the Italian banking sector. [...]