Did European Central Bank boss Mario Draghi save Italy or merely set up the world's third biggest debtor for permanent zombie status?
As Italians head to the polls on Sunday, the parties, big and small, are showering voters with promises of goodies galore. The Five Star Movement, the single most popular party, is plumping for a basic income for the poor. Silvio Berlusconi's Forza Italia (Go Italy) mob is dangling a 23-per-cent flat tax in front of voters. Not to be outdone, its right-wing coalition partner, the Northern League, thinks Italy's economic salvation lies in a 15-per-cent flat tax.
In no case do the promises come with a realistic analysis on how much they would cost, how they would be financed or what damage they would inflict on the budget deficit and national debt. In a sense, it doesn't really matter, for Italy's finances are hardly sovereign any more; politicians can say what they want. Italy is, in effect, a ward of the ECB.
How did a Group of Seven economy become beholden to outside authorities?
Italy is a member of the European Union, which means it has (reluctantly) agreed to abide by certain fiscal rules, notably running a budget deficit that is no more than 3 per cent of gross domestic product. But the control goes well beyond the deficit rules, because Italy could bring down the entire euro zone, perhaps the entire EU, were it to collapse. Italy is sitting on €2.3-trillion ($3.65-trillion) of debt, for a debt-to-GDP of 132 per cent; only Japan and Greece have higher ratios. Given its crushing debt load, Italy could trigger a global financial crisis were investors to go on a bond-buying strike.
That scenario is precisely why the ECB, in 2011, came to the rescue. Mr. Berlusconi was prime minister at the time and obviously in denial about Italy's dire financial shape. A blow-up was clearly coming; imagine Greece times 10.
The bond "spreads" – the difference between the yield on Italian 10-year government bonds and their German equivalents – had been about 200 basis points. It rocketed to more than 550 basis points, at which point the yield on the bonds was so dangerously high that country was in danger of getting shut out of the debt markets. (A basis point is 1/100th of a percentage point.)
Out went Mr. Berlusconi, to the relief of German Chancellor Angela Merkel, whose disdain for the Italian prime minister was palpable. In came a technocrat government, led by economist Mario Monti, bent on quick reform, yet the bond spread barely narrowed.
By then, it was well into 2012. At that point, Mr. Draghi went into panic mode and launched his euro-zone rescue package, which was really a thinly disguised Italian rescue package. It was dominated by so-called Outright Monetary Transactions (OMT), which would allow the ECB to buy, in unlimited quantities, the bonds of any country that was in danger of not being able to sell bonds.
The program was never used; its mere presence was enough to send euro zone bond yields, notably Italian yields, down to safe levels. The bond yields went down even further when, in 2015, the ECB rolled out quantitative easing (QE), the mass buying of the bonds of most of the euro-zone countries. Again, Italy was the big beneficiary. By last autumn, the ECB was the owner of some €300-billion of Italian bonds, a figure that will keep rising until the QE program ends, likely late this year. (It's already being phased out).
The point being, as the saviour of Italy, and the holder of a massive amount of its bonds, the ECB will have a lot of say in how the next government manages its finances, all the more so since the end of QE will push up Italian bond yields. Italy's La Repubblica, the country's main centre-left newspaper, has estimated that the spending and tax cuts touted by the Mr. Berlusconi's three-party, right-wing coalition (which the polls say has the best chance of forming the next government), would blow a €161-billion hole in the deficit.
If Mr. Berlusconi's coalition even tried to pull that stunt, buyers of Italian bonds would go on strike. Of course, Mr. Draghi would read the coalition the Riot Act before that happened.
There is no way the ECB, having pulled the euro zone back from the brink of destruction in 2012, would allow any new Italian government to unleash another crisis.
To be sure, the ECB does not want to be Italy's financial babysitter now or ever. It wants to see a government carry out the reforms needed to boost productivity, trim the deficit and debt, build employment and restore robust growth. Italy is out of recession but growth is feeble and productivity abysmal.
But the ECB has trapped itself. Its rescue programs – dominated by OMT and QE – may have prevented Italy from going down the toilet, but they also served as a handy crutch for the government. By taking the edge off the Italian crisis, the government and the establishment lost all will to push for change.
The result is an ailing economy, one that is of no immediate threat to the rest of the euro zone yet one that lacks the motivation to get its act together. As Italy's decline proceeds, another Italian crisis is inevitable. It's just a matter of time.
An old adage says that no good deed goes unpunished. Mr. Draghi was generous with Italy, and Italy apparently has no intention of returning the favour.
Eric Reguly