– Italy’s Mr Euro urges Latin Front, warns Germany won’t sell another Mercedes in Europe (Telegraph, Nov 4, 2013):
The plot is thickening fast in Italy. Romano Prodi – Mr Euro himself – is calling for a Latin Front to rise up against Germany and force through a reflation policy before the whole experiment of monetary union spins out of control.
“France, Italy, and Spain should together pound their fists on the table, but they are not doing so because they delude themselves that they can go it alone,” he told Quotidiano Nazionale
Should Germany persist in imposing its contractionary ruin on Europe – “should the euro break apart, with one exchange rate in the North and one in the South”, as he puts it – Germany itself will reap as it has sown. “Their exchange rate will double and they will not sell a single Mercedes in Europe. German industrialists know this but all they manage to secure are slight changes, not enough to end the crisis.”
Professor Prodi is the prime minister who prepared Italy for EMU in the 1990s, and then presided over the launch of the euro as European Commission chief. Some readers may remember that I crossed swords with him 15 years ago, but that dispute is ancient history now and has no bearing on today’s economic debate.
He rightly warns that nothing of substance will change as a result of the Bundestag elections. “German public opinion is by now convinced that any economic stimulus for the European economy is an unjustified help for the ‘feckless’ South, to which I have the honour of belonging. They are obsessed with inflation, just like teenagers obsessed with sex. They don’t understand that the real problem today in deflation, as I have been saying for a year,” he said.
This is the nub of the matter. The policy regime has become maniacally restrictive because every decision is filtered through “game theory” calculations, the belief in Berlin that the naughty Latins will somehow cheat unless their feet are held to the fire.
The ECB is playing this game too. It is no longer a central bank. It has become an enforcer of political pressure. The ECB is not even trying to meet its 2pc inflation target. It has abandoned its 4.5pc M3 money growth target and its twin pillar monetary structure.
As the Richmond Fed wrote in a paper earlier this year: “The ECB needs to start recognising that Europe’s problems are more than structural. It needs to stop using monetary policy as a lever for achieving structural changes and to end its contractionary policy.”
Be that as it may, Il Professore said the European Union – which he led for five years – has broken down as functioning system. “Today there is only one country and only one in command: Germany. ”
He said it has long been obvious that Italy cannot restore control over its public finances in recession conditions. “The debt to GDP ratio has been rising for three years despite austerity. It is a failed policy.” (119.3pc in 2010, 120.8pc in 2011, 127pc in 2012, 132.3pc in 2013, according to the IMF’s Fiscal Monitor).
This too goes to the heart of the matter. Italy is a fiscal saint, the only major country in the industrial world to run a primary budget near balance for over seven years, and a surplus this year of 2.5pc of GDP. Yet the debt trajectory is accelerating upwards.
This is entirely due to the “denominator effect”. The contraction of nominal GDP – the result of a quadruple whammy of tight fiscal, tight money, tight credit, (regulatory overkill) and a Teutonic exchange rate – has forced Italy to service a rising debt burden on a shrinking economic base. It is a classic debt-deflation trap, as described by Irving Fisher 1933.
Il Professore says Italy should be given a waiver on the €51bn put aside in budget deficit calculations for EU bail-out policies, giving the country leeway for a mini-blitz on investment. Better still, the Maastricht treaty should be changed to eliminate the 3pc deficit ceiling. “It is stupid that this has not been changed for 20 years. A 3pc deficit makes sense at certain moments, at other times it should be zero, at others 4pc or 5pc.”
Stupidissimo indeed. But instead of revising Maastricht, Berlin has rammed through the even stupider Fiscal Compact, locking Europe into 20 years of chronic deflation and depression. (Yes, you could in theory offset that with monetary stimulus, but the opposite is happening. EMU monetary policy is becoming tighter and tighter as incipient deflation raises the “real” interest rate.)
Prof Prodi says Germany is living in an Alice-in-Wonderland world of intellectual confusion, thinking that it can run a current account surplus of 7pc of GDP (almost three time’s China’s surplus), with an inflation rate of almost zero, without at the same time blocking recovery. But no amount of protest makes any difference. “It has not effect on German policy because France, Italy, and Spain lack any common approach, even though all these countries they have identical interests.”
As readers know, I have been arguing for a long time that the Greco-Latin Bloc and those with shared interests such as Ireland should seize control of the European institutions and dictate the policy with a very sharp knife held to the throat of Berlin’s über-bully Wolfgang Schauble.
They have the majority votes in the EU Council of Ministers. They have a majority on the ECB’s Governing Council, and indeed on other bodies such as the European Investment Bank, which could be mobilised for a Marshall Plan (that empty promise from some wretched and now forgotten EU summit, never delivered like all those New Deal EMU pledges that came before).
They have natural justice, economic authority, and the EU treaties on their side. They can and should deploy their combined political power to impose a full fiscal and monetary reflation strategy on the EU, Abenomics for Europe. Germany might find that a few years of 3pc inflation and a mini-boom are not so painful after all. But if it finds this outcome so intolerable, the exit door is wide open. It can leave EMU. (And destroy part of its banking system in the process.)
As Prof Prodi says, nothing is being done to break the vicious circle – vicious too for Germany in the end, if only they could shake their collective heads free of so many economic shibboleths – because no Latin leader has yet emerged to carry the fight. The issue has apparently become less urgent over the summer as Europe’s recession touched bottom. A few green shoots allowed everybody to engage in another round of wishful thinking, but this is a trap.
In the end, the leadership must come from France, still the great and generous heart of Europe. That may happen yet, even if Francois Hollande gives every impression of being a vacillating amateur, buffeted by events, incapable of saying boo to a mouse. Record unemployment must ultimately stiffen his spine, and if he cannot rise to the challenge, his governing authority in France will collapse, and perhaps the Fifth Republic will collapse with it. We must not let this happen to France.
But the fact that Italy’s Mr Euro is saying such extraordinary things is itself a sign of the tectonic rumblings in the Latin world. Every week it seems that yet another towering figure of the European cause joins the rebels. For me personally, it is refreshing to be part of consensus at last.