Will Italy stay in the Euro-zone?

Larry Kummer, Editor

15 years ago

Summary: The strong often believe that the weak have no choice but to stay in the game (however rigged) and accept whatever cards they’re dealt. While logical, the weak often have the ability to turn the tables. So it is with creditor nations, who often confuse the power of loans with that of tanks — and confuse the morality of the Beatitudes with the claims of a promissory note.

Trouble rather the Tiger in his Lair than the sage among his books. For to you Kingdoms and their armies are things mighty and enduring, but to him they are but the things of the Moment, to be overturned with the turning of a page.
— Ancient wisdom, source unknown — it applies even more to loans than armies

Creditors often assume that they have both worldly power and moral superiority over their debtors. Only God can judge the latter, but history suggests that the former is wrong. Nations that accumulate large debts are locked in a system of trade imbalances which make them as or more vulnerable than their debtors.

The US was a large creditor in 1929, and fell harder than most during the Great Depression.
Japan was the world’s top creditor in 1989, and still has not recovered from the following bust.

Now it’s Germany’s turn. They prospered from exports to the PIIGS which it financed with loans. Now they expect the PIIGS to suffer depressions in order to repay the loans, threatening expulsion from the euro-zone to any who default. The consequences of that are unknowable, but certainly traumatic.

But fear of the unknown might not deter one or more of the PIIGS, as default and devaluation may provide a new start — and be the best path to the future. Here we look at Italy. We cannot predict what they will do; we cannot see beyond choices the people of Italy have not yet made.

Contents

Italy is bust
A more detailed analysis, same conclusion
Barclay’s runs the numbers, gets the same answer
Roubini asks if Italy wants to stay with the Euro?
For more information

(1) Italy is bust

“Italy is bust; it’s just a question of when“, Matthew Lynn, MarketWatch, 8 November 2011 — “Italy has a lot of debt and a lifeless economy … and faces three big problems.”

While government debt may have been fairly stable over the last decade — admittedly at fairly high levels — just about every other type of debt has exploded.
Italy has stopped growing. It has been through 4 recessions since it joined the euro in 1999. Average growth has been just 0.6% from 2000-2010. Per capita GDP growth has been 0.1% over the whole of the first decade of the single currency {while} the global economy was booming …
Italy has the worst demographics in the world. The UN projects that the population will fall to 41 million by 2050 from its current 51 million. Even worse … life expectancy is rising fast. Italian women now have the longest life expectancy in Europe at 83.2 years, and the men are not far behind.

The statistics about the debt load of Italy (and other developed nations) come from “The real effects of debt“, September 2011. See the tables on pp 24-26; you’ll probably find them full of surprises.

(2) A more detailed analysis, same conclusion

“Italy: Too Little, Too Late“, Katharina Jungen et al, Roubini Global Economics, 10 November 2011 — Subscription only. Summary:

Italian debt dynamics have become unsustainable in light of much-weaker-than-expected growth prospects and elevated borrowing costs. Following a sharp loss in market confidence and a buyers’ strike, we expect Italy will be forced to restructure its sovereign debt.
The environment of heightened political uncertainty in Italy has rendered it incapable of tackling the current challenges. The size of the financial assistance needed to support Italy coupled with the inadequacy of the eurozone’s rescue strategy is likely to force the country into a managed debt restructuring as early as 2012.

(3) Barclay’s runs the numbers, gets the same answer

“Can Italy save itself?“, Michael Gavin, Barclay’s Capital, 7 November 2011 — Summary:

The ongoing debt crisis in Greece is a legitimate concern for policymakers and investors, but growing concerns about Italy pose the real danger to Europe and the world economy. Yields on Italian government debt have reached new highs, and are at levels that we consider clearly unsustainable.
We believe that policy reforms in Italy are necessary to increase confidence in the Italian credit. However, historical experience suggests that the self-reinforcing negative market dynamics that now threaten Italy are very difficult to break. At this point, Italy may be beyond the point of no return.
While reform may be necessary, we doubt that Italian economic reforms alone will be sufficient to rehabilitate the Italian credit and eliminate the possibility of a debilitating confidence crisis that could overwhelm the positive effects of a reform agenda, however well conceived and implemented.
… We see little practical alternative to a strengthened commitment by the ECB to act as lender of last resort to precariously positioned eurozone governments.

(4) Roubini asks if Italy wants to stay with the Euro?

“Eurozone Crisis: Here Are the Options, Now Choose“, Nouriel Roubini, Roubini Global Economics, 9 November 2011 — Excerpt (red emphasis added):

Cost of Euro-zone Membership May Eventually Outweigh Benefits, Thus Triggering Exit

Also, the alleged benefits of remaining in the EZ may now be less convincing for most periphery members: Initially, the EZ led to interest rate convergence when market discipline was not operational; this was a significant benefit as nominal and real interest rates were low and falling and making the cost of debt for both private and public sectors low. Now, with market discipline in full swing and sovereign spreads high and rising, this major benefit of the monetary union has disappeared and has rather become a major cost/burden.

Worse, remaining in the EZ implies ceding from now on a significant part of — if not all — fiscal autonomy to the core: Soon enough, the troika will decide most of the taxation and government spending in the periphery, including social safety nets, social security systems and the matters and details of the privatization of public assets. Germany/the core may also effectively take over part of the periphery’s financial systems if the only way to recapitalize periphery banks is by using EFSF resources. Also, the ECB’s monetary and exchange rate policies have now clearly gained — after over a decade of experience — an anti-growth and an anti-competitiveness bias, focusing instead on the strict achievement of price stability.

When national currencies existed, rising differentials in competitiveness — because of differentials in unit labor costs —could from time to time be remedied through nominal and real depreciation of national currencies. Now, that benefit is gone and only recessionary deflation is available.

So, what are the alleged benefits of staying in the monetary union if the costs seem to be rising while the benefits are shrinking? Periphery members are still blinded by the potential stigma of an embarrassing exit, especially policy makers who would lose power if a shameful exit that suggests failure were to occur. So, they are desperately avoiding even the thought of exit rather than seriously and rationally considering its benefits as well as its considerable — but manageable — costs. But populations will not meekly accept year after year of sacrifices, job losses, rising unemployment and hopelessness about an economic recovery. If there is no light at the end of the tunnel or the only light is from the approaching train wreck of a deflationary recession with no hope of a short-term recovery, debt reductions and exits from the monetary union will become necessary, desirable and unavoidable.

(5) Update: A look at Italy, now and in the past

“Italy: not good but we have seen this before“, Antonio Patas and Ilian Mihov, 14 November 2011 — Excellent graphs! Opening:

It is hard to find much optimism by looking at the Italian economy today: Low growth, high government debt, limited confidence of financial markets and no government. Pick a random newspaper or economics blog today and the tone will be on a range from mildly pessimistic to catastrophic. I will not repeat their arguments and instead I will do my best to be a contrarian and argue that maybe it is not as bad as it looks. Or maybe it is, but Italy has managed to live with such a bad situation for years so there is some hope. This might not be enough to turn you into an optimistic but at least it provides a perspective to how similar episodes ended.

(6) For More Information

Share this: