Spain is naturally the focus of all attention at the moment following the €100 billion bank bailout over the weekend, but the bigger problem for Europe is Italy, and it has been since the euro began.
Like Spain, Italy is now in a fully fledged debt trap, where economic growth is less than the national cost of capital. Without the ability to devalue, Italy has no hope of turning this around.
It should never have been admitted to the European Monetary Union and now needs to be exited. The euro should have been the common currency of Germany, France, Belgium, Luxemberg and Netherlands, and still should be.
Italy’s inclusion in the single currency deal between France and Germany was the key item of debate in 1996 and 1997 as decision time on the euro was approaching and the left-wing government of Romano Prodi was pulling out all stops trying to get in.
German Chancellor Helmut Kohl was dead against it because Italy’s 1995 budget deficit was 7.6% of GDP, well outside the 3% required, and its debt was 123% of GDP — more than twice the level stipulated in the proposed rules.
Prodi and his Treasury Minister, Carlo Ciampi, went into a frenzy of lobbying externally — in Bonn and Paris — and internally with the unions, which they had already persuaded to end the indexation of all wages.
In the end it seems to have been German manufacturers who turned the tide in Italy’s favour: they started lobbying Kohl to let Italy in because they were sick of the constant devaluations of the lira making Italian products — especially cars — cheaper than German ones.
And to be fair, Prodi and Ciampi brought down a draconian budget in 1998 that got the projected deficit down to 3% of GDP. In fact, in the event Italy’s deficit for that year turned out to be 2.7% of GDP. Italy could no longer be kept out on the basis of its budget deficit, although its debt was still well above 60%.
As the BBC’s Robert Peston noted in last night’s Four Corners on the ABC, in the end the debt to GDP ceiling was simply waived for Italy and with Germany’s Bundesbank the only one still casting doubt over Italy’s fiscal sustainability, the EU voted Italy in on May 2, 1998.
But here’s the thing: in the 20 years leading up to the start of the euro in 2000, Italy’s and Germany’s industrial production expanded at the same rate, but since monetary union, Italian IP has shrunk while Germany’s has grown enormously.
Without the ability to devalue, Italy’s economic growth stagnated in the past 12% years. The fourth recession in a decade is about to start, and as tax receipts fall and unemployment rises, its budget deficit will blow out even further.
As Charles Gave, of GaveKal Research, said in a recent report: “With lower productivity and a higher cost of capital, one would have to be brain dead to put a factory in Italy, especially if one knows that the tax rate in Italy is going to go up to try to close the budget deficits (as if a tax increase ever led to a reduction in the deficit!).”
Italy is in a debt trap from which it can’t escape without an unlikely reduction in bond rates or an even less likely big increase in economic growth. Improving the liquidity, or even the solvency, of banks won’t solve the problem, nor, for that matter, will some kind of move towards European federalism, as Germany is urging.
Mutualisation of sovereign debt will simply paper over Italy’s lack of competitiveness. Even if Italy kicked off the sort of micro-economic reform process that Australia began with the floating of the dollar in 1983, it would take a decade or more to have any effect, by which time the country would be bankrupt.
Italy needs to do micro-economic reforms such as the privatisation, deregulation, competition policy, freeing up the labour market and tax reform that basically took Australia 20 years to complete. Some things, such as National Competition Policy, are still going. Once it has done those things, then it could be allowed to rejoin the euro.
For the moment though, Italy’s lack of competitiveness and its debt trap, will take a back seat to the immediate question of whether the Spanish bank bailout was enough money.
With the IMF declaring that Spain’s banks need €40 billion in new capital, €100 billion seems like plenty. But ratings agency Fitch says the real figure could be up to €100 billion if the Irish pattern of real estate losses is repeated, and Barclays Capital has come up with a maximum figure of €126 billion.
As a result, this latest bailout looks like continuing the trend of rapidly diminishing relief windows afterwards. This one may have lasted less than a day.
It won’t be long before the Italian elephant in the room raises its trunk and has a blast.
*This article was originally published at Business Spectator
Italy is to emulate Australia’s micro-economic reform by floating the Euro?
It is too late for that reform, the real reform would be to follow free-market practise and devalue the overpriced debt in housing. These assets would then become affordable for those expected to service these debts and the euros which would then be directed to real wealth producing as opposed to wealth dissipating investment in unaffordable housing and create the wealth needed to service these debts (repetition for those who did not understand the concept the first time they read it). This would replicate the immediate post war Marshall Plan policy to restrict spending on housing and concentrate instead on manufacturing.
It would appear, however that History is not part of the materials manifest in the definitely non wealth
producing econofop factories recognised as the various schools of economics across the developed world, they certainly show no signs of having ever read the Wealth of Nations.
Irrational greed and pride, deadly economic sins it seems will killoff the banks unless they repent.
Not very likely. In the meantime the banks remain, not yet dead but paralitic.
are there any free market governments ready to “Marshall” some rational medecine?
This latest euro fix will come apart in less than a month
Another day, another sticking plaster solution from beleaguered eurozone policymakers.
Like all the others, the latest fix seems to create as many problems as it solves. The euphoria in markets at Spain’s rescue lasted all of a few hours; having bounded away at the opening, they ended broadly flat.
Only this one may not even succeed in buying time – I give it less than a month before some such other piece of bad news comes along to fire the crisis anew. Like all the others, the latest fix seems to create as many problems as it solves. The euphoria in markets at Spain’s rescue lasted all of a few hours; having bounded away at the opening, they ended broadly flat.
But please don’t call it a bail-out. It may walk, talk and look like a bail-out, but to the Spanish premier, Mariano Rajoy, Spain’s handout is completely different to the three rescues we’ve already seen, even though at €100bn (£81bn)– or some 10pc of Spanish GDP – it’s quite a bit larger than that of Ireland and Portugal.
No doubt mindful of the fact that every political leader who has agreed on a bailout to date has been defenestrated soon afterwards, Mr Rajoy has attempted to snatch victory from the jaws of humiliation by proclaiming the €100bn of aid an unparalleled triumph. Don Quixote himself would have struggled to see such majesty in all too self evident defeat.
To Mr Rajoy, however, the Spanish aid is no more than “the opening of a line of credit for our financial system”, which because Spain has been such an exemplary to others in accepting austerity without complaint, has been offered more or less unconditionally. I suspect Mr Rajoy is in for a bit of a shock once he sees the fine print, but for him, the important thing is getting it across to his electorate that Spain is not being bailed out. Honour has to be seen to be maintained.
Unfortunately, the reality is altogether different. This is not a direct line of credit to the Spanish banking system, but a sovereign loan which expands the national debt by getting on for 20pc. The fact that all of it is going to be used to prop up the banking sector is no more than cosmetic for an underlying truth – that it is Spanish taxpayers who are left with the liability. Spain is being forced to borrow from Europe to bailout its banks because markets won’t provide the money directly to Spain.
In so doing, the Spanish rescue may well suffer from the same fate as the three previous sovereign rescues. Because the bailout money takes on the position of preferred creditor, it subordinates other bondholders, thereby making it even harder to raise money from the capital markets.
Also stressed to virtual breaking point, Italy, becomes liable for some 17.9pc of the cross guarantees, raising the absurd spectacle of Italy borrowing at 5pc to lend to the Spanish banking system at 3pc. European solidarity may be a noble cause, but there must be limits.
The customised nature of the Spanish rescue will also raise accusations of favouritism from those struggling with the harsh conditionality of previous rescues. Ireland, with a remarkably similar crisis to that of Spain, will feel particularly aggrieved.
Like Spain, Ireland’s problem was essentially that of overexpansion of its banking sector to fund unsustainable construction, property and consumer booms. The consequent losses have overwhelmed the capacity of the sovereign to cope, transmogrifying the original banking crisis into a full blown fiscal meltdown.
Yet Ireland has been treated as a fiscal profligate, and been punished accordingly with penalty terms which Spain seems to be escaping. We should perhaps not feel too sorry for the poor downtrodden Irish. This was a mess largely of their own making, for right at the start of the crisis, the government committed the blunder of unilaterally issuing a blanket sovereign guarantee to all bank creditors in an ultimately doomed attempt to halt the flight of capital. Ireland essentially did for its entire banking system what Britain attempted, again without success, in the single instance of Northern Rock.
As fast became apparent, Ireland could not afford this guarantee, forcing the government to fall back on joint eurozone/IMF support. Ireland’s unilateral state guarantee also caused mayhem in the European banking system, making other European countries particularly unreceptive to subsequent calls for concessions.
Some progress is being made towards a fully fledged federal banking system, with centralised supervision, a single deposit insurance scheme, and a single resolution regime. Potentially, such a banking union could have prevented the sort of crisis we’ve seen develop in Ireland and Spain.
European-wide deposit insurance might, for instance, have given depositors the reassurance needed to leave their capital where it is and quell the cross border flight of capital to apparently safer havens. Similarly, now widely accepted proposals for bailing in bank creditors – subordinated and senior unsecured debt holders – promise finally to break the link between banking and sovereign risk, allowing banks to go through a kind of Chapter 11 bankruptcy process without blowing up the entire economy. For Europe, however, implementation of these proposals is still years away, and in any case come too late to deal with the crisis in hand.
In the meantime, self defeating austerity is throwing stressed economies ever deeper into recession with little hope, outside the implausible promises of policymakers, of any near term return to growth.
It was unwise of George Osborne, the Chancellor, to blame the eurozone for Britain’s economic ills. There are no excuses for the country’s lamentable economic performance. But it is certainly true that the longer the eurozone crisis persists, the worse our chances of economic recovery become. The effects of the crisis are already apparent in plunging business confidence and rising bank funding costs.
The Spanish omelette of a rescue agreed at the weekend brings us no closer meaningful resolution.
Hey S—for Brains, if you are going to cut and paste (badly, of course….) from the UK Torygraph (Telegraph) please provide the credit due to them or are you pretending that you \an think for yourself ROFLMAO LOL LOL
I give it less than a month
Do you indeed, Suzanne? Funnily enough Jeremy Warner, Associate Editor of The Telegraph, thinks the same. In fact he thought the exact same 978 words that you did.
SUZANNE BLAKE, recipient of this site’s “inane” award, is proof positive of the deleterious effect constant exposure to indoctrination has especially on the feeble minded.
TUMBRELPUSHER
Posted Tuesday, 12 June 2012 at 10:14 am
What he/she said!