A Tale of Two Marios, Part Deux

I believe that one critical problem at the moment is that financial markets and the political class are still talking past one another. Given the levels at which they are trading, we can assume that financial markets, conditioned, like Pavlov's dog, by 30 years of the Greenspan put, fully expect the ECB to come out with these kind of tough-talking statements, but are convinced that, one policymakers see the gravity of the situation, they will open the spigots and begin financing the Italian state. However, I see the prospect of a much darker scenario emerging - I think there is a very strong possibility that the ECB will refuse to step beyond its mandate to finance Italy (or at least, will refuse to do so until it's too late, which amounts to the same thing). The main reason for this is that the ECB has been trying to tell us, in as plain a way as central bankers can manage, for some time, "our mandate is price stability; we cannot finance government borrowing - it would require treaty change". In short, the ECB, genuinely or not, is arguing that such action would be illegal - it is deliberately painting itself into a corner. Why would it tie itself to the mast like this if it were not serious - it is one thing to say "We won't do this", but quite another to say that "We can't do this, it's illegal". I think the ECB is trying to tie its hands to provide a credible signal to the market, and the politicians, that they had better sort this mess out, because they will see no help from the central bank. The market, however, knowing that the ECB is the Bundesbank in drag, has discounted this, as I said above. The irony of this, of course, is that we are currently in a state where a simple statement by the ECB that they are prepared to spend say, €2 or 3 trillion euros buying peripheral bonds as neccessary would solve the problem, combined with the anticipated supply-side reforms in Italy, and (hopefully) Spain. Italian bond yields would go to 400 bps instantly. Every day that passes, however, brings us closer to that time when the market will simply take borrowing costs out of Italy's reach entirely (and it will happen very quickly, probably sooner than we think). By that time, we may then reach a situation whereby the entire eurozone banking system will be effectively insolvent (already some French banks have difficulty borrowing in dollars). Italy may well be Europe's Lehman - the spark that lights the powder keg to spread contagion across the continent and the world. The problem, then, is that by the time that the ECB realises it is the only institution that can act, and the euro itself is collapsing before its eyes, it may be too late.