Germans May End Up Running the Eternal City

If a week is a long time in politics, two weeks covering affairs of state in Italy can seem like an eternity. Maybe that's why Rome got its moniker, but having covered the fall of Berlusconi and the rise of Monti's technocrats, there's some relief things moved along quicker than I and investors feared.

Less than two weeks ago it was still conceivable Silvio might hang around until elections in February, but there's nothing like a bond market blowout to concentrate minds; 24 hours later the Prime Minister was stepping down.  

At that point the ECB decided to step in to bring yields back down again, hitting 6.3 percent last Monday. But then with signs of Monti having problems getting cross-party approval for the makeup of his Cabinet, the ECB sat back and yields started to rise. On Wednesday, Monti had his cabinet, confidence votes were assured and the ECB was again in heavily trying to cap the increase.

The pattern is set. Do the right thing and you'll get support, don't and you're on your own. It's a strong arm strategy that we first saw used over Greece. Here Europe's leaders moved from doing whatever was necessary to protect the euro, to publicly saying yes it's possible to leave. But this is a high risk strategy.

Admitting the euro can break up means investors will start pricing that in, which is exactly what's happening with rising core bond yields. The biggest danger is that this fast becomes a runaway train that nobody can stop. Germany refuses to countenance the answer is fiscal transfer. For them the ultimate end is fiscal union where all budgets have been centrally approved and to qualify every member has become like them.

Now, quite apart from whether this is the right economic structure for Europe, (when everyone starts saving like Germany, who's going to buy German goods?) the big issue is how do we get to this utopia. The Germans insist it's only by wince-inducing reform. Belt tightening and budget slashing will have to come on top of recession and youth unemployment rates that are already well over 40 percent in Spain and Greece, and close to 30 percent in  Ireland, Portugal and Italy.

But the Germans and the Eurocrats have a theory. By and large the people of Europe will put up with anything to keep the euro if they can sell the idea that the crisis will be used to create the type of currency zone we should have had in the first place. Recent polls in Greece showing 70 percent want to stay in the euro are proof to them of a willingness to accept the sacrifices. Even in Italy, faith in their politicians and political system is so low quite a few individuals told me they'd be happy to have the Germans run things, on the basis that at least the sums would add up and there'd be no corruption.

It's quite a theory; I've got a feeling it will be tested to destruction.