Mario Draghi: Fears of Italian debt spiral

"We must act fast. The sorts of interest rate rises seen over the last three months, if protracted, could lead to an uncontrollable spiral," said Mario Draghi, who takes over as head of the European Central Bank next month.

Mr Draghi said austerity measures must be enacted "immediately" and warned that Italy’s €54bn austerity package is "not enough".

Yields on 10-year Italian bonds surged above the danger level of 6pc in August on recession fears. Intervention by the ECB saved the day but yields have been creeping back up again as the ECB steps back. Yields rose to 5.71pc yesterday. Germany’s Bundesbank is adamantly opposed to further ECB bond purchases.

Mr Draghi hinted that ECB help is nearing its political limits, evoking Italy’s "atavistic temptation" of waiting for an army to cross the Alps to sort out its problems. "It is not going to happen. All our citizens must be are aware of this. It would be a tragic illusion to think that the help will come from outside," he said.

Mario Draghi fears Italian debt spiral, Ambrose Evans-Pritchard

One should fear an Italian debt spiral, yes. However, fiscal consolidation is an anti-growth policy that leads to higher deficits in the short-to-medium term. So what Draghi is saying doesn’t make a lot of sense. What Draghi should be worried about it is the ECB’s lack of support for Italy. The ECB is the difference – at least as far as liquidity issues are concerned. Longer-term solvency is an entirely separate issue.

These guys don’t get it.

10 Comments
  1. Bernd says

    This is probably of only tangential relevance to the Draghi quote, but I do believe you are wrong in terms of the conclusions you are drawing. Obviously you are right, when you say “What Draghi should be worried about it is the ECB’s lack of support for Italy.”, but politically you are dead wrong. The current discussion in Germany is centred more or less on whether austerity(/markets) should rule supreme or whether there should be some intervention ( http://www.faz.net/aktuell/wirtschaft/europas-schuldenkrise/schaeuble-und-issing-im-streitgespraech-sollen-die-griechen-raus-aus-dem-euro-11486535.html ). It´s not about fundamentals, it´s about signalling, the Greeks all of a sudden finding 1.5bn€ to push a deadline out by a month, did not go down well at all in northern Europe…
    A fair few commentators are expressing the opinion that northern Europe is getting played by the banks and the more corrupt southern European countries(Greece,Italy, Cyprus).
    Even Germany´s Karl Rove(Michael Spreng) is predicting, that the game is up in terms of further bank bailouts without serious restrictions on the industry( http://www.sprengsatz.de/?p=3741 ).
    So yes, you are right, that “The ECB is the difference – at least as far as liquidity issues are concerned.” technically, but politicaly longer term solvency is an issue that Greece and Italy will have to deal with right away, at least in terms of measures being implemented irrevocably.
    Spain, Ireland and Portugal are a different issue, in terms of the general perspective, these three countries basically have a functioning government and are making an effort and were trying to run sound policies before the financial crisis.

    1. Edward Harrison says

      Bernd, I don’t follow you. I haven’t drawn any conclusions other than that austerity reduces medium term growth and that the ECB can provide unlimited liquidity.

      The other conclusion to draw here is that Draghi wants to show that Italy will get no special favors from him. That is the real impetus behind his statement.

      1. Bernd says

        I guess I made my point poorly. I don´t really disagree with any of what you say in terms of purely technical prescription. What I do think you miss and what Draghi quite obviously understands, is that there is no trust left towards Italy or Greece. Not in northern Europe, not even in France. Any further measures without a quid pro quo i.e. reforms in exchange for help is just not going to happen politically. A country like Spain or Ireland which had it´s house in order in terms of what was considered prudent policy prior to the crisis, obviously does get the benefit of the doubt and quite frankly I haven´t seen too many articles demanding further measures what these countries are concerned. What I was arguing, was purely that neither Italy nor Greece inspired a lot of confidence before the crisis(Italy being a special case with it´s north(=Switzerland) – south(=Magrehb) division) and does not seem to be getting a lot in political terms. I guess this is what Draghi absolutely understands and you seem to ignore in terms of your conclusion.

          1. Bernd says

            I did read the two post you mentionened above, again I don´t disagree with you in terms of what would technically be wise. I have actually been reading your blog for quite some time, I believe you also mentioned at some point that you were moving from policy advocacy to policy analysis. I guess this is were we seem to disagree:

            You state that: “…what Draghi is saying doesn’t make a lot of sense.”
            Whilst according to Evans-Pritchard:
            “Mr Draghi hinted that ECB help is nearing its political limits”, which is definetely not a technical argument, but politicaly and in terms of possible future actions probably a fairly realistic one.
            So yes, in terms of policy advocacy I do believe you are right, in terms of analysis; not so much.

          2. Edward Harrison says

            Bernd, I’m pulling my hair out. It’s as if you are willfully choosing to misunderstand or misrepresent. This has NOTHING to do with the politics. It’s about economics.

            Draghi COULD have said:

            “we won’t give the Italians any more money until they show they are willing to make the structural changes that we believe are necessary to ensure the nation’s solvency.”

            Instead, he said that the austerity was “not enough” and that “We must act fast. The sorts of interest rate rises seen over the last three months, if protracted, could lead to an uncontrollable spiral”, insinuating that more austerity would help end the debt spiral they are now on. This makes no sense because it seem as if he thinks austerity will decrease the deficit when everyone has seen that it has increased deficits in Spain, Italy, and Greece.

            Yes, austerity can address solvency issues by permanently reducing expenditure. But it will only make liquidity issues WORSE because the deficit will INcrease in the short-to-medium run. Draghi doesn’t seem to get that and neither do you.

          3. Edward Harrison says

            Now that I am at it, I have just thought about the politics too:

            https://pro.creditwritedowns.com/2011/06/the-political-economy-of-the-european-sovereign-debt-crisis.html

            “Eventually, the extend and pretend approach will fail after successive rounds of the same policy response in Greece, Ireland and Portugal. Eventually, a combination of four things will occur:

            the people in the periphery countries rise up and overthrow the existing order forcing a default;
            the poor economy that austerity entails forces leaders to move to the hard restructuring route as fiscal consolidation fails
            markets become skittish about Spain or Italy, which cannot be bailed out. So EU leaders will cut Greece loose
            popular unrest in core countries against bailouts grows so severe that they force a hard restructuring or default”

            I have been very consistent in saying:

            — that people are fed up with the bailouts in the eurozone (https://pro.creditwritedowns.com/2011/05/why-i-wont-support-more-bailouts.html) (https://pro.creditwritedowns.com/2011/09/slovenia-deals-another-blow-to-euro-bailouts.html)
            — that Greece and to a greater degree Italy and Portugal and a lesser degree Spain are seen as distinct from Ireland (or Latvia, Estonia) because they have not made enough reform or austerity efforts (https://pro.creditwritedowns.com/2011/07/greece-cut-loose.html)
            — that Greece (and Italy and Spain) will only receive help on a quid pro quo basis for structural reforms (https://pro.creditwritedowns.com/2011/08/ecg-will-not-provide-liquidity.html)

            At least politically, I am making the SAME case as Draghi. How can you claim my political analysis is wide of the mark? You must be reading something into those posts referenced above because what I am saying is that these bailouts will fail for the four reasons enumerated in the quote above.

          4. Edward Harrison says

            Let me keep at it here because the evidence of the consistency of what I am saying about my read of the politics is overwhelming:

            https://pro.creditwritedowns.com/2011/08/on-eurobonds-and-italian-default.html
            “The bottom line is this: many in Northern Europe see this crisis as the result of the fiscal profligacy of bad actors which were known before the Euro’s existence to be bad actors. All of these countries except Spain have been running huge deficits throughout the last decade. In my view, Edward Hugh makes the right macro assessment – Italy is the elephant in the euro room, not Spain – and asks the right question: Can Italy Grow Its Way Out of Debt? If it can’t and there are no eurobonds, eventually Italy will default and the euro will be finished.”

            https://pro.creditwritedowns.com/2011/09/munchau-eurozone-breakup.html
            “There is no stomach for a full fiscal union. That’s not going to happen. Moreover, Germany is preparing for Greek bankruptcy. The markets see this as a near certainty, so it makes sense to get out in front of the event.
            […]
            Bottom line: without growth or fiscal surpluses, Italy’s debt to GDP grows. That’s how the numbers work. Miraculous growth is not going to happen for demographic reasons (Italy is old). So you have to see cuts to get the debt levels down.”

            So when AEP says “Mr Draghi hinted that ECB help is nearing its political limits”, I agree 100%
            (http://twitter.com/#!/edwardnh/status/124252882689196032)

        1. Edward Harrison says

          Also see here where I make the point directly:

          ” My sense is that the Germans will not let Italy or Spain go down. They do want their quid pro quo in terms of ‘structural reforms’ for offering aid, however. Moreover, the ECB will not buy Italian

          and Spanish debt without this quid pro quo. We first heard this via Morgan Stanley’s Elga Bartsch and now Bundesbank head Weidmann is saying exactly the same thing (see the link in bullet #7 above). And if you read the Interview with Peer Steinbrück above, you will see that even the SPD which is out of power is saying the same thing. So the consensus is aid in exchange for structural reform.”

          https://pro.creditwritedowns.com/2011/09/sovereign-debt-crisis-what-traders-are-talking-about.html

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