Column: Market euphoria misreads the signals from Brussels and Rome

Reuters News
Posted: Apr 25, 2013 1:08 PM
Column: Market euphoria misreads the signals from Brussels and Rome

(Anatole Kaletsky is a Reuters columnist but his opinions are his own.)

By Anatole Kaletsky

(Reuters) - Financial markets, which balance judgments from some of the world's most highly paid and best-informed analysts, are often uncannily right in anticipating unpredictable events, ranging from economic booms and busts to elections and terrorist attacks.

But markets can sometimes can be spectacularly wrong, especially when it comes to politics. A classic case was the slump on Wall Street after last November's election in the United States. This week's market action in Europe may offer an even clearer example of market confusion about two fascinating but byzantine political entities - the Italian government and the European Central Bank.

European stock markets have rebounded strongly this week in the face of deteriorating economic and financial fundamentals from across Europe on the basis of two political events: the reluctant agreement by Italy's 87-yearold president, Giorgio Napolitano, to serve another seven-year term because nobody else could be found to do the job; and hints from ECB council members that they might vote to cut interest rates from 0.75 percent to 0.5 percent next Thursday.

Neither of these events remotely justified investors' euphoria. The ECB case is straightforward. First, the ECB may well disappoint next week, since several influential decision makers oppose a rate cut. Second, even if the ECB does act, a quarter-point cut will do nothing for economic growth. Third and most importantly, such a tiny rate cut, if it happens, will simply underline the ECB's refusal to follow the U.S. Federal Reserve, the Bank of Japan, the Bank of England and the Swiss National Bank in expanding the money supply or taking other "unconventional" measures that could potentially have a much greater financial impact than any marginal fiddling with interest rates. So much, then, for the silly idea in Europe that "bad news is good news" because economic weakness will force the ECB to cut rates.

Italian politics is, as ever, more interesting and convoluted. The apparent winners from this week's events were the strongly pro-euro President Napolitano and his new center-left prime minister, Enrico Letta. In fact, they were the losers. The real winner was Silvio Berlusconi, the nemesis of Napolitano and other responsible Italian politicians and a totemic hate figure for German Chancellor Angela Merkel, along with most other respectable European leaders.

To understand this counterintuitive conclusion, which is widely shared by the financiers and business leaders I met in Italy this week as the election drama unfolded, let us begin with what most investors and responsible politicians across Europe interpreted as this week's good news.

Napolitano's re-election, denounced by comedian Beppe Grillo's populist Five Star movement as an "elite coup d'etat," has allowed the aging president to appoint a politician from the center-left Democratic Party (PD), which secured the largest share of votes in last February's election, to head a pro-euro technocratic administration likely to be modeled on the outgoing government of Mario Monti.

Thus, Italy will now have a functioning democratic government, and one that will stick to most of the Monti policies approved by Brussels and Berlin. Moreover, this government is likely to be stable for at least the next six months, since all the established parties have agreed that a new electoral law must be prepared before the next election to prevent a repeat of the present chaos and to try to block Grillo's advance.

This means that the direst possibilities suggested by Monti's humiliating defeat last February and the unexpected gains by Grillo and Berlusconi have been eliminated, or at least postponed. There will be no serious effort to reverse Italian fiscal austerity policies before the next election and certainly no more threats to break up the euro of the kind voiced by Grillo and Berlusconi in February's election campaign. Hence the euphoria in financial markets and the sighs of relief in Brussels and Berlin.

Now for the bad news. While Letto, the new prime minister, is formally a member of the PD, the machinations that led to his appointment and last weekend's re-election of Napolitano have essentially destroyed this center-left party. This has left Berlusconi's center-right People of Liberty (PDL) as the only organized political force in Italy capable of holding off Grillo's anarchic insurgency.

Moreover, by orchestrating Letto's sudden emergence as prime minister, Berlusconi has cut off the political oxygen for a potentially much more popular young center-left leader, Matteo Renzi, the mayor of Florence, who might have had a chance of reviving the PD. And best of all from Berlusconi's standpoint, the new Letto government will not enjoy its own parliamentary majority and will therefore be subject to instant dismissal if it takes any action that conflicts with Berlusconi's personal interests or political strategy.

What all this means is that Berlusconi should not only be able to keep the judicial immunities he enjoys, and which are widely seen as a key motivation for his entire involvement in politics, but also that he will ensure that his party benefits from revisions in electoral laws.

Better still, by pulling strings in the background but not joining the government, Berlusconi will avoid being tainted by the economic hardships Italy continues to suffer. By the end of the year, he should be able to blame the center-left, the euro-technocrats and Germany for Italy's problems even more effectively than he did at the last election and to present himself as a national savior from the chaos threatened by Grillo's anarchic Five Star Movement, which by then may be Italy's only effective left-of-center party.

So what European financial markets have been celebrating this week is the astonishing re-emergence of Silvio Berlusconi as the dominant figure in Italian politics - and therefore as the ultimate arbiter of whether Italy will abide by the economic conditions laid down by Berlin and Brussels or possibly trigger a breakup of the euro. If Berlusconi had been openly elected as Italy's president or prime minister, investors would surely have been less euphoric.

(Anatole Kaletsky is an award-winning journalist and financial economist who has written since 1976 for The Economist, the Financial Times and The Times of London before joining Reuters. His recent book, "Capitalism 4.0," about the reinvention of global capitalism after the 2008 crisis, was nominated for the BBC's Samuel Johnson Prize, and has been translated into Chinese, Korean, German and Portuguese. Anatole is also chief economist of GaveKal Dragonomics, a Hong Kong-based group that provides investment analysis to 800 investment institutions around the world. )

(Anatole Kaletsky)