Is it easy to guarantee Italian debt?
No, no no, says I. Here is a recent post by Karl Smith, another by Brad DeLong. In those posts there is not enough emphasis on public choice problems and the longer term and the forward-looking nature of markets. The Italian economy does not have per capita growth over the last twelve years, and it is increasingly thinkable it won’t have growth any time soon, even apart from recent problems with aggregate demand. Population is aging and shrinking and institutions remain dysfunctional. In the comments, Morgan Warstler put it well:
There’s no free lunch – this is not about past debts (debt can be written off), it is about accepting the inevitable future…
There is the same problem over time for any ECB strategy; it’s not enough to break the back of the speculators once or twice. Karl writes:
…Italy doesn’t actually need anyone to transfer real resources to it. It simply needs someone to manage resource distribution among bondholders. The ECB can do this at virtually no direct cost.
I would have written:
Italy is in primary surplus now but the economy is a train wreck which will only worsen; markets see this. Italian politics still seems quite dysfunctional. Even managing resource distribution among bondholders is going to be problematic, as this redistributes wealth away from German and other AAA citizens and becomes institutionalized quickly, also cutting off chances for reform in Italy.
If Germany and a few other, smaller AAA countries were to guarantee or monetize the debts of Italy, Spain, and possibly France and Belgium, never mind Greece and Portugal, Germany would not be AAA itself. The German median voter has very little interest in guaranteeing the above-mentioned debts. If German yields are flipping upwards, it is, in my view, because investors now see the whole euro deal as unraveling and don’t want to deal with the complexities and flak. A big chunk of the German auction didn’t sell at all. You don’t have to think that Germany is ripe to default to see that markets are warning Germany not to take on the whole burden.
Furthermore, there is no “half hearted recovery” in the offing, not even with better AD policy. A lot of institutional arrangements were set up in an unstable fashion and now they are unwinding, as indeed they had to do, with economic carnage along the way. The periphery countries all thought they were wealthier than they in fact are, and behaved as such, but now is the painful unwinding, including the collapse of a lot of ultimately unworkable EU governance structures. Markets now see this, and the ECB cannot so easily reverse it.
Addendum: You don’t need complicated arguments why I am wrong in my europessimism when there is a simple argument. If countries are willing to dig into their wealth, they can pay off their debts. Basta. At the core it is a public choice problem, not an accounting argument. The optimistic forces can win the accounting argument, but so far the optimistic forces have called the crisis wrong every step of the way.
Kantoos adds comment.