Not exactly how Romano Prodi would admit that the cat was out of the bag in his native tongue, but, thanks to him, one particular issue is now well and truly out in the open. His statements on Italian inflation and the euro have, at last, drawn attention to problems highlighted by Euromoney in our cover story in April 1998.
Prodi said that if Italian inflation rose much more, the strains on the economy caused by membership of the euro would be too much to bear and that Italy might, in those circumstances, have to pull out of the eurozone. This is the most sacrilegious thing a eurozone politician can say. After all, there is no mechanism in place to allow countries to leave the euro once they have joined. Apostasy is so unthinkable it is legally impossible.
His remarks may have been caused by his upbringing. Prodi, one of seven siblings, is described as religious and sensitive to the needs of the less-well-off members of society. He is from the Emilia Romagna region whose inhabitants are considered by other Italians to be generous to a fault and always ready to fight any form of injustice and inequality.
So perhaps a realization of the effect on Italian unemployment spurred the prime minister to voice what Europe’s leaders all know but are not saying, that with foreign exchange and fiscal remedies to economic problems in an individual member country neutered by monetary union, the labour market has to take up the slack. But while in the US people can and do move from North Dakota to Florida in search of work, it is ridiculous to assume that more than a tiny percentage can move from Scandiano (Prodi’s birthplace) to Salzburg – or anywhere else outside their home country.
Whatever Prodi’s motive for speaking out, the markets should once again consider what happens if a country should leave the mechanism. What happens to that country’s existing debt? What happens to the remaining members of the euro and indeed the currency itself?
Interestingly, Prodi’s comments didn’t spook the markets at all. One of the most surprising aspects of the new euro market is not how well it is pricing the different credits but how poorly. Despite the widely differing ratings and financial situations of their issuers, eurozone sovereign bonds trade within a very narrow band. When Prodi made his statement, instead of immediately pricing in the increased probability – however slight – that Italy would leave the euro, Italian bonds did not move at all. Instead the market took its revenge on the currency itself. The euro weakened significantly.
This suggests the markets believe that, despite the terms of the Maastricht Treaty, there is a bail-out mechanism for countries in difficulty. The other members of the federation will rally round, pumping money into their dislocated neighbour, in the process diluting the harsh tenets of Maastricht. In which case, maybe the politicians would like to come clean so that we can establish the true value of the new currency.
