The ECB Puts the Screws On the Italian People

From the beginning, the European Central Bank (ECB) made its choice: Euro banks get unlimited liquidity while sovereign nations must institute painful austerity programs in exchange for bailout crumbs.  GDP growth is declining in general but in “good” countries like Ireland, which did everything the Troika asked for, unemployment increased exponentially and the misery index went vertical.

Italy is now the focus.  Investors are demanding ever higher yields on Italian debt, which leads to dropping asset prices and collateral calls, and then Italy has to pay even higher yields until it can no longer cover the cost of running its government.  If Italy goes, there goes the eurozone.

Even with Berlusconi gone, replaced by Prime Minister-designate Mario Monti who cut his teeth at Goldman Sachs, on Monday Italy had to pay almost 100 basis points more (6.29%) than it did a month ago for a 5-year bond (5.32%).  Its 10-year bond yields at 6.77% increased to more than three times that of the 10-year German bonds.

Popular sentiment is that the southern euro countries are getting what they deserve for profligate spending and widespread corruption.  But Italy has been a solvent nation with the economic resources to service its 1.9 trillion euro ($2.6 trillion) debt.  Italians save at a higher percentage of income than Americans.  As events escalate, facts fall by the wayside and investor fear and distrust take over.

The Federal Reserve in the U.S. acts as lender of last resort if necessary and puts the full faith and credit of the United States behind its massive IOUs.  Buyers still flock to the perceived safety of Treasury bonds despite its recent ratings downgrade from AAA to AA.  The 10-year U.S. Treasury bond yield is 2%.  The ECB emphatically refuses to expand its single mandate, fighting inflation, to include issuing Eurobonds, which would lower bond yields for suffering nation-states.  It fights fiercely to dispel the impression that it might backstop the debt of a country whose bankruptcy could drag other countries down with it.  French banks, for instance, have large holdings of Italian sovereign bonds.  

The ECB is not above manipulating markets to achieve the results it wants.  

There are memos indicating that it held back on purchasing Italian bonds in order to force out Berlusconi.  The ECB could float the perception that it would backstop accelerating debt.  That might be enough to calm investor fears and drive down bond yields.  Since last year it bought 187 billion euros’ worth ($256 billion) of sovereign bonds on the open market.  That’s a drop in the bucket.

The financial-industrial complex is firmly in place.  The Troika has already installed their own people as overseers to police the austerity program.  Mario Monti, economic technocrat, has already 

outlined plans to upend the Italian system:

In Italy, Prime Minister-designate Mario Monti began talks to create a new government of non-political experts as a letter has appeared outlining Italy’s plans for austerity including plans to cut 300,000 public-sector jobs by 2014, raise the pension age and cap the amount of debt local governments can carry.

Without an ECB nod in the direction of Eurobonds or operating as the lender of last resort, a psychologically-driven endgame can lead to countries falling like dominos into bankruptcy.  But the Germans are in charge.  Their people are vociferously opposed to any accommodations for its southern neighbors even if they bring themselves down in the interim.  They fear inflation.  Historically, it’s hurt them badly.  Most economists dismiss that result as the entire eurozone, impacted by overwhelming debt and austerity programs head into double-dip recessions, higher unemployment, higher taxes, spending cuts and lack of demand.  However, without the consent of Germany, the strongest economy in the euro area, there doesn’t seem to be a force strong enough to prevent Ferraris from driving straight into a brick wall.