The two poles now agree that the severity of the crisis largely comes down to Italy and the European Central Bank. The optimists argue that Mario Monti will save the day. Not only will Italy’s new prime minister push through some reasonable austerity measures, the optimists insist, he will also persuade Germany not to demand yet more budget cuts. The sympathy and support of the German government matters a great deal, primarily because of its influence with the ECB.
If we were still living under the “no bailout” conditions of the gold standard, as it actually operated before 1914, Italy would have no hope. The market has decided that Italy has too much debt and too little growth. As these expectations become more negative and interest rates rise, it becomes harder for Italy to issue new debt and make the required payments on existing obligations. Projected government debt levels become explosive.
Today’s world, of course, has moved far from the gold standard because central banks can provide credit and create money. The central banks are limited only by their credibility, or the level of confidence by the financial system that policy makers will keep inflation in check.
Copyright 2012 The National Memo