The cold douche begins. Markets will now learn that the European Central Bank’s bond plan is a devout wish, not a done deal. Europe’s political minefield lies ahead.
Nothing can happen until Spain and then Italy request a rescue from the EU bail-out funds (EFSF/ESM), and sign away their sovereignty. Nothing further can happen until an angry Bundestag approves the terms and signs away its money.
Germany has a 27pc voting weight and can veto any rescue.
Even less can happen if the German constitutional court issues a preliminary ruling on Wednesday blocking activation of the €500bn ESM fund. Morgan Stanley’s team – mostly Germans as in happens – put a 40pc likelihood on this happening.
This is not to belittle the ECB plan for “unlimited” bond purchases. The Jesuit-trained Mario Draghi has pulled off a masterstroke, securing the assent of every northern ECB governor except the Bundesbank’s Jens Weidmann, and crucially the assent of Germany’s board member Jorg Asmussen, and indeed Chancellor Angela Merkel herself.
Italy’s premier Mario Monti – a fellow `Jesuit’ – more or less confessed that this minor revolution could not have happened without the defeat of French leader Nicolas Sarkozy in May. The election upset broke the Franco-German axis and reordered the strategic landscape of Europe.
In a poignant exchange here at the Ambrosetti forum – a gathering of the world policy elites at Villa d’Este on Lake Como – he talked of intense “psychological pressure” from Paris and Berlin in the early months of his tenure. It all changed three months ago with the liberating arrival of President Francois Hollande.
This was the birth of the Latin Bloc. Mr Hollande was no longer willing to stick doggedly to the same destructive course or endorse the German morality tale that “sinner states” alone are responsible for Europe’s woes.
A grown-up view has at last prevailed. This is a crisis of capital flows and trade imbalances, a dysfunctional structure in which Germany itself is an equal “sinner” – a meaningless term in economics – in as much as it clings to a mercantilist trade advantage over Club Med through a distorted intra-EMU exchange rate.
Nor could the Draghi breakthrough have happened without the diplomatic arm-twisting of China and America. President Barack Obama found his intellectual soulmate in Mr Monti, telephoning him for every update on Europe’s drama, treating him as de facto president of Europe, concentrating the full might of the United States behind the very different Monti narrative of the crisis.
Mrs Merkel has bowed to vastly superior global power, but only partially. Italy and Spain will each have to sign a Memorandum accepting “severe” conditions. It will not be enough to meet their existing deficit targets. They will have to do more.
If the Latins had any sweet illusions, these were surely dashed by the explosive response of the German media and political class to the Draghi Plan. “It will drive Germans to the barricades,” said the unusually unflappable Suddeutsche Zeitung; it is “blank cheque”, said Bild Zeitung. The euro is “kaput”.
Outrage from the Free Democrats (FDP) was predictable and can be ignored. They face near annihilation as a political movement. The blistering critique from the Social Democrats (SPD) is more ominous. “Merkel has allowed the ECB to become an ersatz government,” said Carsten Schneider, the SPD’s budget spokesman.
We can expect the Bundestag to impose Carthaginian terms, and there lies the rub. With Spain and Italy already in debt deflation spirals – and youth unemployment at 53pc and 35pc respectively – the limits of the politically possible are approaching.
Spain said it will study the terms very closely before deciding. Finance minister Luis de Guindos reminded the creditor bloc that the battle for the survival of the euro will be fought in Spain, a choice of words that some took as a renewed threat to walk out of EMU -if pushed too far- and bring down the temple on Germany’s head.
Mario Monti said here in Cernobbio that it would “not be a drama” if Italy ultimately needs help. His Finance Minister Vittorio Grilli said otherwise in a room down the corridor. Italy has “absolutely no need” for the anti-spread shield. If the markets are not confused, they should be.
The reality is that Italy’s Left and Right are both deeply wary of EU-IMF Troika intervention, leaving a collapsing centre as elections loom early next year.
Any such Memorandum would bind the hands of a successor government. It would force the Left to swallow pro-cyclical austerity ex ante. “It would be self-harming to request help from the fund if there are any extra conditions,” said Stefano Fassina from the Democrats (Pd).
Il Giornale – the mouthpiece of the Berlusconi family – called the plan a “trap”, a surrender of sovereignty to German hegemony and the “party of the bankers.” Better a return to the lira.
Mr Monti must steer a delicate course, redoubling reforms and pushing through a budget control office in the hope that this will placate investors and keep bond yields low enough for long enough for the crisis to pass.
My own guess is that events in Spain will intrude rudely. Bond yields will ratchet up again if Madrid tries to tough it out. Euphoric markets will come to realize that nothing has yet been solved.
The fallout from the deepening global downturn may intrude too. The world is uncomfortably close to an inflexion point. We risk the sort of moment we saw in mid-2008 as a “negative feedback loop” kicked in with a vengeance.
The eurozone recession – self-induced by austerity overkill and bad monetary policy before Mr Draghi took charge – has combined with the Chinese hard-landing in a mutually-reinforcing fashion. All we need now is the US `fiscal cliff’ and we could soon face Nouriel Roubini’s perfect storm.
Mr Monti warned here at Villa d’Este that Europe’s affairs are once again being poisoned by tribal animosities. That is what slumps do to political systems.
He spoke of “dangerous antagonisms” and the ever-growing temptations of populism. “The clash between the North and South is causing old tensions and stereotypes to re-emerge, threatening the disintegration of Europe,” he said.
Everybody can agree on that, but not on a solution. Former Spanish premier Jose Maria Aznar told the same audience that the drive for full fiscal and political union is deeply misguided. “A United States of Europe is an impossible idea. It is a very serious mistake to try to destroy the nation states. You cannot go against the cultural beliefs of the people and the forces of history,” he said.
The Draghi Plan is a unquestionably a transforming step. The tail-risk of a sovereign defaults in Italy and Spain must be taken off the table. It was recklessly irresponsible for EU leaders and authorities to allow the second pillar of the world’s monetary system to break down altogether and remain in paralysis for over a year, and we all know was responsible for that epic misjudgement.
Yet the ECB’s willingness to act – once the EFSF/ESM trigger is pulled – is plainly not enough in itself to save the euro. Primat der Politik is back in tooth and claw. Democracies will make or break EMU.