European Central Bank president Mario Draghi has been awfully kind to the clapped-out members of the euro zone, all in the name of sparing the common currency from destruction. But his time is coming up. The next ECB boss might take a No-More-Mister-Nice-Guy approach and, if so, the euro zone and debt investors are in for a shock.
Mr. Draghi says arrivederci to the ECB next autumn, at the end of his eight-year term. The hunt is on for his replacement and European news sites are already handicapping the race.
The leading contender is said to be Jens Weidmann, the economist who is president of Deutsche Bundesbank (the German central bank) and a member of the ECB's governing council. He has opposed almost all of the ECB's showcase policy decisions during the Draghi era. At the height of the European crisis in 2012, he reportedly came close to resigning after Mr. Draghi promised to do "whatever it takes" to save the euro. Recently, he has been highly critical of the ECB's deflation-busting quantitative easing (QE) program, which has seen the bank buy about €2.5-trillion ($4-trillion) of euro-zone bonds since its launch in 2015.
Among all the euro-zone countries, it is Italy, the euro zone's third-largest economy, that should worry the most about the arrival of Mr. Weidmann or another candidate with traditional views on how the ECB should operate. The biggest threat to the euro during the crisis years was never Greece; it was Italy, burdened with a debt worth 132 per cent of gross domestic product, 30 per cent youth unemployment, meagre growth and an endless string of shaky governments, each allergic to economic reform.
Now, after the inconclusive March 4 Italian election, more threats have emerged. One is months of political stalemate as the leading parties – the populist Five Star Movement and the right-wing, euroskeptic League – separately or together try to bang together a coalition government. Given the fractious nature of the new parliament, any coalition is bound to prove short-lived. Another is the likelihood that any new government will go on a spending spree that will add more poison to Italy's already toxic debt stew.
It was Italy's near financial collapse in 2011, when its sovereign bond yields reached crisis levels, that the ECB was pushed into its new firefighting role. In came the promise to buy the bonds of any country – read: Italy – in danger of getting shut out of the debt markets. Next came QE. While QE prevented inflation from turning negative, there is little doubt it also kept the Italian bond market alive.
At last count, the ECB was sitting on €350-billion of Italian government bonds, making it their second biggest holder.
QE is being slowly wound down as euro-zone growth picks up and inflation, while still below the 2-per-cent target, is sturdy enough to calm the ECB's nerves. The program is supposed to end late this year, but here's a guess on my part: As long as Italy is bent on slow-motion economic suicide, the ECB, under Mr. Draghi, will find some way to keep buying Italian bonds to prevent their yields from tracing the arc of a ballistic missile.
And the next ECB boss? He or she might take a different view on how to protect the euro.
Historically, the ECB has done so by fighting inflation. Lately, it has protected the euro through QE, which had the pleasant side effect of keeping Italy intact (Greek bonds were never included in the QE program).
The new ECB boss might decide that the ECB can't bend the rules forever to keep buying Italian bonds. Should he get the job, Mr. Weidmann would certainly agree that any overt or covert Italian bond-buying effort is finished, under the argument it constitutes monetary financing of a government – a big no-no under European Union rules.
Whether he or another ECB boss would actually cut Italy loose depends on your view of the independence of the ECB. On paper, the ECB's policy makers are fully independent. In practice, it's hard to imagine that the ECB would make a decision that would trigger an existential change in the euro zone without a nod from the German chancellor and the French president, the most powerful figures in the European integration project.
If Germany and France can't imagine the EU and euro zone without Italy, which is a founding member of both, it's hard to see how the ECB can stop doing favours for Italy. If they think Italy, through perennial failure to reform coupled with rising euroskepticism in Rome, is evolving into a greater threat than asset to the euro, they might be happy if the ECB were turn its back to the Italy, opening the door to its exit from the euro (League leader and ultra-euroskeptic Matteo Salvini has said the euro was a big mistake for Italy). Remember, the ECB exists to protect the euro, not the 19 countries that use it. A euro used in fewer countries might be stronger than a euro used by all.
Italy doesn't have to panic as long as Mr. Draghi is running the ECB. But his time is coming up, and so may be Italy's. The next Italian government, and the huge number of investors in Italian bonds, might want to consider the risks of the ECB's probable waning love affair with Italy, especially if Mr. Weidmann gets the job.
Eric Reguly