Chasing lost credibility

02.11.11 Publication:

What is credibility? In one of his films, Groucho Marx might have said that credibility, alongside integrity, is essential in life, and if you can fake that, you´ve got it made. At the very least, financial markets are now indicating that they believe the Eurozone´s government leaders all faked their credibility when announcing their supposed “comprehensive” solution to the sovereign-debt crisis on October 26th. The challenge now is how to get that credibility back.

The most immediate reason for financial markets loss of confidence is Greece, since clearly the Greek government´s announcement of a referendum on the rescue deal raises a genuine possibility of a Greek default on the country´s sovereign debts, since a default is the only real remaining option if voters reject the deal. The biggest questions, however, surround not Greece but the eurozone´s other trouble sovereign debtors, which chiefly means Italy.

If Greece was the eurozone´s only problem, the solution would be easy: if Greek voters do not like the conditions being imposed on them in return for financial support, they can leave the euro. The problem is that Greece is not alone. The comprehensive deal on October 26th was supposed to make it, in some senses, alone, by “ring fencing” it from other big debtors. Yet that effort at erecting a fence failed. And, in the markets´ view, the failure can be blamed both on those countries trying to build the fence, and on the countries on other side of the fence, chiefly Italy.

The fence-builders failed because they did not agree to commit a sufficient amount of money to the task of protecting Italy–in other words, they did not provide enough money to buy enough Italian government bonds to compensate for the gap being left by banks and insurers selling their holdings, both now and potentially in the future. The reason they did not commit enough money is not just meanness. It is that, for different reasons, neither France nor Germany felt politically able to accept the collective liability for Italy´s present and future debts that such a commitment would imply.

This is unlikely to change, even if the current drama turns into a full emergency, because neither Chancellor Angela Merkel nor President Nicolas Sarkozy believes that their countries´ voters will accept the national costs and sacrifices that taking on such collective liability would entail. That is why they chose to continue their strategy of the past year, namely of putting up a bit of money in the hope that it would buy time.

Time cannot, however, be bought so easily when credibility is missing. If markets could be convinced that, in a true emergency, Germany and France would accept collective liability, then the time-buying strategy could work. But democracies are transparent entities. Just as everyone knows that Greece will have to default, so everyone knows what German voters think about taking on Italian or Portuguese debts.

Italy´s democracy has many flaws, but in this respect it is the same as Germany´s: it is transparent. That is why, despite the austerity measures in the summer, and despite last week´s letter of intent from the Italian government about the future measures on debt and growth that it says it plans, investors feel they know what is going to happen.

They feel that they know that few, if any, of the measures listed in the letter will be implemented, because they know that the coalition is divided about them, they know that trade unions are opposed to the labour measures, and they think they know that early elections will be called for April 2012, before most of the measures have been implemented.

If Silvio Berlusconi´s government had established long ago a reputation for seriousness, for carrying out its promises, for making painful decisions, probably this would not matter. Investors would believe the measures would be implemented, and would not worry that an election would also happen. But this is not the case: all experience suggests the opposite to the markets: that the government is not serious, and that it will do whatever it can to avoid making and implementing painful decisions.

For once, this might even be unfair. But it is too late to complain about that. Life is unfair. Especially when credibility has vanished. Whatever Groucho Marx might like to think, it is now too late to fake it.