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Europe’s Financial “Phony War” Coming to an End

There are more signs that the financial “phony war” in Europe is ending. Wolfgang Münchau at the FT writes:

The Monti magic seemed to work for a while – much longer than I had expected. The yields on Italian 10-year bonds dropped about 200 basis points during his term because investors, desperate for good news, wanted to believe the magic.

But Mr Monti’s year in office has been a bubble, which felt good for investors while it lasted but has deflated. And it will probably take Italians and foreign investors not all that long to realise little has really changed over the past year, except that the economy has fallen into a deep depression.

Between Hitler’s conquest of Poland and the start of his western offensive six months later, it looked as if World War II was going to be a bust. The armies weren’t moving, nobody was charging the trenches. Observers called it the phony war, or sometimes the Sitzkrieg.

But then came the spring and the war was on full force.

European financial markets have been enjoying a bit of a phony war lately. There’s been a feeling that Mario Monti’s government in Italy has more or less put Italy on a sustainable path. But, as Münchau points out, the calm in Europe rests on shallow foundations.

Monti’s reforms in Italy were not nearly as thorough or effective as the always-active Complacency Lobby in Europe thought. And without much more dramatic relief than the tight fisted Germans have been willing to offer, there is no real prospect of an Italian recovery inside the euro anytime soon, which means that the country’s distressingly high debt-to-GDP ratio will inexorably worsen even as Italy enacts severe and unpopular budget cuts. A bigger Greece with better food.

Monti was a can kicker of a technocrat, and he has kicked the can closer to the end of the road. It is hard to predict when the financial markets will determine that the time has come to test the illusory European stability, but on the basis of Münchau’s logic, that time cannot be all that far off.

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