Monti Drives Stake in Euro’s Heart — Sends Italy Down Greece-Paved Road!

As I watched the ECB news conference on Thursday, I kept wondering how the ECB president, Mario Draghi, could have so completely rejected the idea that the ECB will get into the “periphery bond buyer of last resort” business.

Why is this important?

Because many believe it will be impossible for the euro to succeed unless the ECB steps in the breach with a massive quantitative easing program for the euro zone’s periphery countries.

After announcing a quarter of a point rate cut on Thursday, and explaining the ECB would accept lesser quality collateral from euro-zone banks and take up steps to increase liquidity in the system, Drahgi started taking questions from reporters.

Gone was the obfuscation and horse manure usually slung by former ECB chief Trichet. And in its place was an extremely candid Draghi who virtually said:

Those of you out there in the press who expected me to back the idea of me sanctioning some type of bond-buying bazooka with ECB funds can go fly a kite.

On that news, the euro started sliding down from its high and was hammered lower on the day. Take a look at the 30-minute chart of EUR/USD:

It wasn’t just the euro reacting negatively to Mr. Draghi’s comments — bond spreads widened across Europe. And Italian 10-yr bond yields, which represent the canary in the coal mine, surged higher in response:

At this critical stage in the effort to save the euro, Mr. Draghi’s news conference was a disaster of the first order. But the real stake in the heart of the euro likely came earlier in the week when the new technocratic prime minister of Italy, Mario Monti, pushed through a draconian plan, which he named “Save Italy.”

The package hopes to raise 30 billion euros ($41 billion) from spending cuts and new taxes, including: A property tax, a new levy on luxury items like yachts, an increase in the value added tax, a crackdown on tax evasion, and an increase in pension age.

It made Frankfurt and Brussels happy, but will likely destroy the Italian economy.

Greece was forced into a similar budget that was supposed to be the medicine for revival. But instead, it turned into self-induced suicide of an economy.

Italy needs approximately €300 billion in financing in 2012. So it was important for politicos to show the market that Italy is indeed getting their “house in order” with a powerful and disciplined austerity plan that will put the country back on the road to fiscal health and growth. So on top of the €24 billion in austerity measures announced by the former leader, Mr. Berlusconi, we add another €30 billion to the pot last Monday by newly enshrined PM Monti.

All’s good, right?

Wrong!

Let’s use the lesson of Greece as an example …

Greece’s austerity plan back in May 2010, when its 10-year yields stood at around 8 percent, was a mix of tax hikes and wage cuts that represented approximately 3.5 percent of its GDP. At the time, Greece’s debt was about 120 percent of GDP.

We know the Greek economy collapsed as tax revenues plunged. Unemployment soared. Debt jumped to 170 percent of GDP. And the 10-year Greek bond yield rocketed to about 30 percent.

I’m not sure why we should expect a different outcome from the new austerity plans the technocrats tell us will solve Italy’s problems. If anything, the liquidity background in Europe and global growth backdrop is even worse now than it was back in May 2010.

What’s more, Greece had similar low bond yields and about the same debt-to-GDP as Italy has now. So if Italy follows down the path of Greece, it means the end of the euro as a single currency. Keep an eye on the canary!

Best wishes,

Jack

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