Political pin pops Monti's bubble

Mario Monti's decision to resign leaves Italy's new leader facing a political mess and a tough choice – push Germany for debt mutualisation or leave the eurozone.

The announcement by Mario Monti that he intends to resign as Italy’s prime minister tells us two things: politics is intruding, and the crisis is getting worse again.

I have always respected Monti as a European commissioner and a wise observer of European affairs, but I am more sceptical about his performance as Italy’s head of government. The sometimes uncritical adulation he enjoyed was based on the notion that you could solve Italy’s problems by putting politics aside, imposing a few reforms and a lot of austerity. The consensus in Italy was that only a technocratic government could deliver these policies.

The Monti magic seemed to work for a while – much longer than I had expected. The yields on Italian 10-year bonds dropped about 200 basis points during his term because investors, desperate for good news, wanted to believe the magic.

But Monti’s year in office has been a bubble, which felt good for investors while it lasted but has deflated. And it will probably take Italians and foreign investors not all that long to realise little has really changed over the past year, except that the economy has fallen into a deep depression.

There are now two things that need fixing in Italy, both of which are intensely political and beyond the scope of technocrats.

The first is to reverse austerity immediately – essentially to undo Monti’s work. The tax rises and spending cuts are having a counterproductive effect. By reducing both debt and growth, the debt-to-GDP ratio has increased in the short term and I doubt that it will fall by much in the long run. The deterioration in Italy’s debt sustainability will become much clearer next year, as we get more statistical evidence of the calamitous effect of austerity.

The effects are already being felt before the 2013 budget kicks in. The tax burden on Italian families almost doubled this month – a result of the introduction of a new property tax system – which has had the immediate effect of killing off the pre-Christmas retail business. Confcommercio, an association of service companies, estimates a consumption fall of 13 per cent.

The second priority is to stand up to Angela Merkel. This was something Monti was unwilling – and incapable – of delivering. He tried a bit of grandstanding at the European summit in June, but he never managed to confront the German chancellor on the one issue that mattered: that without some form of debt mutualisation – a eurozone bond – it was hard to see that a country with a debt-to-GDP ratio of 130 per cent and virtually no growth could remain a member of the eurozone, and keep on rolling over its debts for ever. Only an elected leader is in a position to force a choice. A technocratic prime minister cannot be expected to produce a credible counter-threat if the answer is no.

I am often asked what Germany would do if confronted with the choice between a eurozone bond and an Italian departure. I believe that Berlin would blink first in such a stand-off. The reason Monti was so popular in Germany is because his bubble and his austerity played into the chancellor’s hand of delaying hard decisions on debt resolution and institutional reform beyond next year’s German elections.

Is the required type of leader in sight? Pier Luigi Bersani, the recently elected leader of the Democratic party, is clearly not that man. He is part of the conservative wing of the centre-left that is supportive of Monti’s austerity and less supportive on structural reforms – the worst combination.

Matteo Renzi, the young mayor of Florence who lost to Bersani, would have been a more likely candidate to bring self-confidence back to Italian politics. But with the latter on top, I expect the establishment will now try to fashion him as the man most likely to inflate some air back into the bubble.

Another possibility is a return of Monti as a campaigning politician, and candidate for a centrist alliance.

What about Silivo Berlusconi, whose return to frontline politics triggered the impending departure of Monti? He will not become prime minister. Italians have had enough of him, though he still enjoys some residual popularity among the right.

Whatever one thinks about Berlusconi may have been, his diagnosis of Italy’s problems since he left has been spot-on. He has said Italy needs a new deal in the eurozone and that even a departure should not be treated as taboo. And he has said repeatedly that austerity is not working. He should have said that when he was prime minister.

The outcome of the election is further complicated by the anti-euro Five Star Movement led by Beppe Grillo, which has maintained second place in the polls for some time.

The best outcome for Italy would be a political leader who forces the issue of Italy’s future with a clear-headed sense of what choice the eurozone and the country will need to make. Otherwise, Italy risks being pushed into a position like that of Greece, which pursued similar policies and has no choices left.

Copyright The Financial Times Limited 2012.

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