By Anatole Kaletsky
April 25 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
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.