Italian Prime Minister Mario Monti will resign shortly. And his predecessor Silvio Berlusconi is poised, in the best traditions of burlesque English Christmas pantomime, for an attempted comeback that — whether it succeeds or fails — promises to be spectacular and disruptive.
Italy's Prime Minister Mario Monti
Berlusconi’s chances of a fourth prime ministerial term after elections possibly as early as February look slim. The center-left Democratic party headed by former communist Pier Luigi Bersani, is placed by opinion polls well ahead of Berlusconi’s revamped People of Liberty party.
The world will watch with fascination and trepidation as a discredited billionaire showman-politician seeks to refuel his electioneering machinery. Even a shadow of a possibility that the former right-wing premier may return would send a tremor through financial markets. And Bersani, though judged a reasonably competent possible future leader, will never be termed as solid as Monti.
The Italian drama presents an intriguing counterpoint to one of the most important international financial policy changes in recent years, announced last week: the reversal of the International Monetary Fund’s long-time policy on capital controls, itself partly prompted by European upheavals.
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The IMF shift, after a thorough three-year review of the past two decades of financial history, move the Fund’s policies powerfully in a direction favored by emerging market economies.
On the European scene, any hint that Berlusconi could re-enter Rome’s Palazzo Chigi would complicate further enactment of the European Central Bank’s vaunted but unused Official Monetary Transactions program, agreed in September, for potentially unlimited purchases of weaker countries’ bonds.
In August 2011, Jean-Claude Trichet, then president of the European Central Bank, and Mario Draghi, his successor, then governor of the Banca d’Italia, sent Berlusconi a confidential list of necessary reform measures, widely seen as conditions for ECB purchases of Italian debt. The letter sparked a chain of consequences that led to Berlusconi’s eventual resignation and replacement by Monti in November 2011.
In early August 2011, at the height of a bond market scare, Italian 10-year government bond yields stood at over 6% , a spread over equivalent German yields of more than 3.5 percentage points.
Showing the scale of the task confronting the Italian authorities, even now, after favorable market reaction to the OMT announcement in recent months, Italian spreads are still around 3 percentage points, although the absolute yield in absolute terms has fallen more sharply to around 4.4%.
The Italian imbroglio is linked to last week’s IMF announcement accepting curbs on movement of international capital into and out of countries affected by economic overheating. Such measures have been used extensively by emerging market economies in recent years in an attempt to ward off the kind of destabilizing capital movements that affected Europe in the flare-up in the European Monetary System 20 years ago, as well as in the continuing euro crisis.
Last week the IMF stated that there is “no presumption” that “full liberalization [of capital movements] is an appropriate goal for all countries at all times.”
For years, and especially since the 1997-98 Asian financial crisis when countries like Malaysia sought to introduce controls on speculative movements to damp excessive exchange-rate fluctuations, the international consensus as broadcast by the IMF was firmly on the side of liberalization.
Violations were condemned as significant infringements of the world monetary rule book. The IMF ignored the historical fact that measures to prevent speculative inflows and outflows were central elements of the post-Second World War Bretton Woods system of fixed exchange rates.
Now, however the IMF center of decision-making gravity is moving heavily in favor of Asia and Latin America.
The IMF’s espousal, under certain conditions, of what it coyly calls capital flow management measures, bears the hallmark of influential Asians such as Singapore Finance Minister Tharman Shanmugaratnam and Zhu Min, deputy IMF managing director and former vice governor of the People’s Bank of China. The new guidelines reflect, too, the arguments of influential critics of global conventional financial wisdom such as Rakesh Mohan, former deputy governor of the Reserve Bank of India, Bank Negara Malaysia Gov, Zeti Akhtar Aziz, and Brazilian finance minister Guido Mantega.
Especially at times of low growth and interest rates in Western industrialized countries, such authoritative critics say developing countries have no choice but to take measures against short-term capital inflows that would otherwise expose them to the risk of recession-inducing exchange-rate appreciation.
Singapore’s Tharman, who is also the country’s deputy prime minister, told an economic conference in Malaysia last week that, “A lot is good about capital flows, but you can have too much of a good thing.” Small open economies like Malaysia and Singapore had to take measures to curb volatility to reflect that they “have not felt comfortable in leaving exchange rates solely to market forces.”
The IMF’s ideological shift reflects, too, monetary-policy mistakes and miscalculations in Europe. Echoing the Asian financial crisis, the euro area’s post-2009 turbulence was preceded by growing economic imbalances and excessive current-account deficits in peripheral euro member states. Relatively high rates of inflation and low interest rates in these countries produced self-fueling excessive real exchange-rate appreciation and economic overheating.
Rising current-account deficits were more or less ignored by the European and international monetary authorities. These shortfalls were financed by volatile short-term capital inflows, which flowed out again once private- sector creditors concluded that their lending had become too risky.
Emphasizing the dashed illusions, Rodrigo de Rato, the veteran Spanish economic policy maker who was IMF managing director in the crucial pre-crisis years of 2004-07, said in London last Friday: “The belief that current-account deficits didn’t matter was a huge mistake.”
Historians will surely conclude that Europeans would have improved handling of their own vicissitudes if they had taken more seriously the lessons of the Asian financial crisis.
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