My current read on the euro crisis has been scattered over a number of posts, so let me sum it up here: the ECB's LTRO (a promise to accept longer-dated troubled sovereign debt as collateral in 3-yr repurchase agreements) has calmed the bond markets for the time being and created the appearance that the PIIGS might muddle through. But the ECB's condition for this arrangement--drastic and binding budgetary restrictions across Europe--holds the potential for triggering political unrest, as even conservative Martin Feldstein warned yesterday in a post linked to below.
Now, Mario Monti, the technocrat who replaced Berlusconi in Italy, has also issued a plea to Berlin based on the same fear--that the political center cannot hold. There will be "a powerful backlash" in the European periphery, he warns. He calls upon Germany to recognize its own "enlightened self-interest" and argues that Germany "has reaped huge benefits ... perhaps more than others" from the euro.
This is about as blunt as it gets in central banker-speak. Although Berlin shows no signs of receiving the message, I think that in fact there is quiet panic both there and in Frankfurt. My hunch is that the current consensus is highly unstable and will come apart at the first sign of trouble, which could come soon, either in the wake of an outright Greek default, which is imminent, or with signs of political tension in Italy or Spain. And then the question will be how the ECB manages its capitulation. The problem is that as long as the consensus holds, pressure to reform European institutions toward a more sustainable solution diminishes. So nothing is happening on that front, although the French downgrade led Die Zeit to say yesterday that the "end of Merkozy" had arrived. Sarkozy and Merkel used to look each other in the eye, the paper wrote, but now the Frenchman's stature has been diminished by S&P (though, truth to be told, I think he was always looking up to Merkel, figuratively as well as literally). And in May, Sarko will either be re-elected or not, at which point French policy will probably shift toward a more aggressive line on EU institutional reform.