Question: Unemployment has reached a record high in the euro area. Is this a price worth paying for the structural adjustment that you think is necessary to make the euro work?
Draghi: I agree that it is a very hard price to pay, but it is unavoidable. The only way to mitigate the impact of this budgetary consolidation, which is contractionary in the short term, is to undertake structural reforms that could increase competitiveness and exports, as well as create jobs and growth.
----Mario Draghi, ECB press conference, Dec. 6th, 2012
I hope that my government can help change Italian mentality.
---Mario Monti, Italian PM
The inability of Europe's "best and brightest" to learn from four years of failed policies means that the eurozone crisis will drag on for years and will continue to send shockwaves to the global macroeconomy.
Here's a puzzle: Look if you will at the two Marios, Monti (Italian PM) and Draghi (ECB president) who are dominating the headlines these days. No one would deny that both are exceptionally intelligent and perceptive men. Any country or central bank would be happy to have either of them at the helm. They are both Ivy League-trained economists (Monti at Yale, and Draghi at MIT). Either of them can think rings around most European or American politicians.
And yet, they are pursuing economic policies that can only end in disaster, not only for Italy, but for Europe as well. How can we explain their persistence in pursuing destructive policies?
I can offer a political explanation for their behavior and a psychological one, but neither are really adequate. Politically, neither has sufficient authority to reject the Bundesbank's deflationary orthodoxy, and to embrace reflationism. Psychologically, Italian technocrats like the two Marios have always labored under the prejudice against southern Europeans that they are lazy and corrupt. It is understandable that proud and honest Italians such as these would like to prove that Italy and the other Latin countries are not inherently inferior to northern Europe, and can live with a hard currency and low inflation.
It would be hard to argue that the two Marios know that the policies they are pursuing are wrong. Clearly they believe in what they are doing. They have convinced themselves that austerity, deflation and depression are, in the long run, good for Italy and for the eurozone. After all, every northern country has gone through austerity at least once since 1980 and they have all emerged stronger and more competitive. Why shouldn't the south? Their thought-process is that starvation is painful in the short-run but beneficial in the long run. (See Draghi's remarks above.) If so, then one must ask: how large must the mountain of contrary evidence and human suffering grow before they can admit error?
I can appreciate Monti's position: he wasn't inserted by Europe into the Italian job in order to hijack the ECB or to exit the eurozone. He was installed to act as Europe's governor-general to ensure that Brussels' orders were carried out, and that corrupt politicians were unable to steal Germany's money. Monti never had a chance to successfully revolt, although he tried half-heartedly at the June summit. He showed a brief glimmer of rebellion, but achieved nothing.
Now Monti wants to quit, and who can blame him? An honest professor in Italian politics is like Mother Teresa in Vegas. But I must say that his premiership has failed. After four long years, Italy has not recovered from the crash and remains mired in recession. Its economic outlook (and credit) outlook is bleak.
Europe's only remaining hope is for the struggling countries to unite and confront Germany head-on. Monti, Hollande, Rajoy and the others must demand that (1) the ECB target growth and not deflation, and (2) that the ECB buys the bonds of the peripheral countries without conditions or limits. If they don't do that, then eurozone growth will remain negative, fiscal revenues will stagnate, deficits and debt will grow, credit spreads will widen, and eurozone breakup will occur.
Which brings us to Draghi and his "friend" Jens Weidmann of the Bundesbank. Draghi has placed a very high premium on "institutional credibility" and governing council consensus, and an apparently low premium on successful policy-making. It is true that the ECB has a single mandate (price stability) that it has fulfilled much too well. But does the ECB really have a mandate to recreate the Great Depression, to bankrupt the peripheral countries, and to destroy the eurozone? Was that the intention of EMU?
It is astounding to me that a central bank of the importance of the ECB can casually forecast a shrinking GDP for 2013, as if growth were an exogenous variable like bad weather. The ECB's forecast confirms its failure. Apparently Draghi and Weidmann are happy with a prediction of a recession and zero nominal growth.
Italy's GDP today is smaller in nominal terms than it was in 2007, industrial production is down 20%, and youth unemployment now stands at 26%. In Frankfurt, this is taken to mean that the bank's policies are "on track".
The unwillingness of Europe's best and brightest to learn from experience means that the eurozone crisis will get worse not better, and will hang as a Sword of Damocles over global growth and financial stability for years to come. In broad terms, I think that most of this risk is already baked into US equity valuations. But we can expect periodic macro-shocks as Europe's tectonic plates shift under the weight of its unsustainable policies.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.