The sixty days allotted to save monetary union have expired. The G20 has come and gone, yet no workable firewall is in place as the drama engulfs Italy and threatens to light the fuse on the world’s third largest edifice of debt.
As of late Friday, the yield spread on Italian 10-year bonds over German Bunds was a post-EMU record of 458 basis points. This is dangerously close to the point where cascade-selling begins and matters spiral out of control.
The European Central Bank has so far bought time by holding a series of retreating lines but either it has reached its intervention limits after accumulating nearly €80bn of Italian debt, or it is holding fire to force Silvio Berlusconi to resign – if so, a foolish game.
The ECB’s hands are tied. A German veto and EU treaty constraints stop it intervening with overwhelming force as a genuine lender of last resort. The bank is itself at risk of massive over-extension without an EU treasury and single sovereign entity to back it up.
This lack of a back-stop guarantor is an unforgivable failing in the institutional structure of monetary union. As Berkeley professor Brad DeLong argues in a new paper, such “utter disregard for financial stability – much less for the welfare of the workers and businesses that make up the economy – is a radical departure from the central-banking tradition.”
The Bank of England was forced to jettison such reactionary nostrums in 1825 after the canal boom burst. It intervened in breach of its own mandate, over howls of protest by the hard-money men who warned that the “millennium of the paper-mongers would be at hand.” A near century of gentle deflation followed....MORE