Thursday, November 24, 2011

Italian Debt; Part 1 - Bye Bye Bunga Bunga

Earlier this summer I gave some of my impressions on the economic situation here in Italy. Much of the big economic news this summer was about Greece, but in reality, it was never about Greece. Greece could fail every year for all eternity, and it would register as little more than a blip on the world's radar. It was always about Italy- maybe Spain- but certainly Italy. Greece (and Portugal and Ireland) were always just a testing ground for what would happened if Italy starts to get stretched too thin. After Greece's latest bailout, the EU created a bailout fund designed to do two things: support European banks after their write-off of Greek debt, and attempt to provide support should something happen to Italy. Volumes could be written about just that first objective, let's just say this bailout will probably be a drag on the entire Euro area economy. But the second one, was designed to reassure the markets about Italy in particular. It's hard to say what their legitimate hope was, a permanent cure or just a time-buying measure, but it looked like big stuff. Lots of zeroes and the like to support even the bigger troubled economies of Italy and Spain.

The latest reactions in the markets have been nothing short of disastrous. Italy's borrowing costs were around 5.5% when the latest "Ultimate Solution" was being cooked up, earlier this week it hit a high a of 7.2%, an increase of 31% in about a month. Disaster in the making essentially. There could only be three reasons why the markets decided to abandon Italy so remarkably: They didn't like something about the Greek bailout, and they hoped new European Central Bank (ECB) President Mario Draghi was more willing to get his hands dirty to help the situation more than his predecessor was, they were scared Berlusconi would never leave.

But Berlusconi has gone now, and indeed, Italian debt got some small relief on Thursday and Friday. I think it is a little unfair to suggest that Berlusconi was the problem in Italy. His finance minister, Giulio Tremonti, always did his best to keep Italy above water. Not that Silvio appreciated him much for this, it was rumored that the two spoke to each other little or not at all during the last tumultuous few months. I think the market's fears, if rational, were more based in a concern that there would be some (unpredictable) kind of revolt against a Berlusconi who had clearly outstayed his welcome in Italy. The markets were demanding austerity measures that would be very unpopular, and if these measures were coming from a man as unpopular as Berlusconi himself, well, who knows what might snap within Italy.

But as of this weekend, Silvio is gone, and the markets have their wish as a technical government including essesntially all parties except Berlusconi's allies the Lega Nord. The new Premier will be Mario Monti, a man I believe relatively unknown to most Italians. He is a former professor who has made his career as a very high level EU bureaucrat. As such he isn't tainted by party politics, and seems the ideal man for the job. His government will undoubtedly do the cuts that must be done. For how long he will remain in place is unclear, elections aren't scheduled until 2013 at the moment.

But there will be great hardship to come here in Italy, and a certain part of me hopes the Lega Nord goes rogue, and whips up a significant anti-EU sentiment in Italy. It has to do with those other two reasons for the run on Italian credit I mentioned before: this Greek bailout, and what the ECB is up to. I wanted to lead with the lighter reading before encouraging you all to roll back your sleeves and dig in to unpleasant world of Economic theory and thought experiments. It won't be so bad.

Friday, August 5, 2011

A quick wise crack

When I wrote the first of my posts on Italian debt, I thought it would be material that would be little more than a curiosity for my American friends.

Well, we just broke your stock market. Your welcome! : )

Sunday, July 31, 2011

Can't things just stay calm for a few days while our new baby is born?

All ready to write my part 3 to see what's in store for Italy and the Euro in the future, when I stop for a couple weeks to welcome my new baby. All that's happened since then is:

- Italy's politicians coming together to quickly pass an austerity budget to pacify the debt markets. That almost none of the cuts kick in for two years apparently didn't bother the markets too much: the interest rate Italy's being charged for new loans fell a couple points after it passed. They were probably amazed by the lack of the usual drama and disfunctionality in Italian politics.

- The EU puts together a bigger bailout than expected for Greece, with about 20% of the savings coming from the banks holding Greek debt taking losses- also a surprise development. European debt markets in general take a breather. So attention naturally turns to...

-The circus in the U.S. congress. I don't even want to get into this ridiculousness for the moment. I will make these brief instigations though:
Fact- America's fiscal policy will take a sharp change in direction due to the Republican's stunt. Obama and the democrats showed no inclination to make the kind of cuts in this budget only a few months ago.
Opinion- Does that mean Boehner won? The republicans got much of what they wanted. but America also saw that Tea Party members were willing to inflict a potentially devastating blow to America, just to get its way.
Curiosity- Where have all the republican presidential hopes been during all this mess? I'm not living in America so I admit I might miss something, but how is it one of those guys isn't saying, "Look at all these idiots!" and then finding a more common sense plan to rally an obviously dissatisfied electorate.

-Then just when nobody was looking, Spain and Italy start to get pounded again in the debt markets, and Spain's unpopular government announces elections in a few months.

The new Greek bailout was larger than expected, but nobody thinks Greece is past its problems yet. The Economist actually quoted a higher-up at Deutsche Bank as saying that "at least Greece has a fighting chance" of not needing another (3rd) bailout. How's that for confidence? But what has inspired some confidence was the new mechanism set up by the EU designed to automatically provide financial support to Greece, Ireland, or Portugal if needed. The EU is finally giving a pretty explicit guarantee that at least these little guys won't go bust. Problem is this mechanism is way to small to be able to save Italy or Spain should they go bust. It's entirely up in the air if the EU can/would save either of those countries if things turn south.

So from what I've seen, both the people who support the bailouts and those who hate the bailouts agree there are only two final solutions in sight here. One: disaster leads to a country having to leave the Euro, or perhaps even the entire Euro dissolving. Two: the Euro countries further integrate and have a united fiscal policy. This could mean the creation of "Eurobonds"- basically Germany and the other "good" countries co-signing the same way parents help their kids borrow money for a new car. The kid pays, but if he can't Mama Germany and Uncle France will have to cover it. This is a legally explicit financial guarantee, a symbolic step the Northern European countries wanted to avoid. It could very well mean austerity in countries like France if this keeps up.

Europe looks likely to circle the wagons for now, and this financial integration may well happen. But the Euro will shake with every domestic election that brings an anti-EU party into government, as happened already in Finland recently. It seems the Euro is going to be under serious threat for quite some time to come.

Monday, July 18, 2011

Italian debt: The Prequel

By special request- more on Italian debt!

So, how did Italy wind up in this dire state? In a word, tradition. By that I primarily mean two things. First, Italy has a long tradition of huge public debts. Second Italy is a traditional country- old ideas, old people.

Anyone who ever had the chance to see the old Italian Lira would certainly have noticed the large number of zeroes on each note. When Italy changed over to the Euro the Lira was valued at about 1900 Lira per 1 Euro. I complain now because I can only get one Euro for a $1.40. In Italy's 150 year history the only time the public debt was below 60% were the 30 years after the US eliminated Italy's debts through the Marshall Plan- Italy's golden years. It has breached the 100% level during four different periods for a total of about 40 years of its 150 year history.

So Italy has a long history of dealing with these problems. This near constant indebtedness led to the funny money quality of the Lira. Quick Econ 101 break: When a country is going broke, it usually has two weapons at its disposal- fiscal policy and monetary policy. Fiscal policy is what Washington is going nuts over right now- the budget. Spend less than you earn, and you can use some of that money to pay your debts. Of course, as Greece will tell you, a penny-pinching government ends up pinching everyone. Monetary policy is essentially when a government thumbs its nose at the people who loaned it money. They do this by devaluing the currency the debt is valued in. "What we owe 10 billion? Add another zero to the Lira!"

Using fiscal policy to get your way out of debt causes great short-term pain. Using monetary policy also causes short-term pain (inflation), but this is somewhat balanced by an entirely positive benefit- any company that exports just saw its products get 10 times cheaper in foreign markets.

But when Italy tightened its belt one last time in the early 90's to convince Europe to let it into the Euro, it meant the end of printing out new Lira to pay their debts. There could only be one monetary policy for all the countries in the Euro, and everyone knew the powerful Germans would really decide for everyone else. Why doesn't Germany/the EU just pull an Italy and inflate its way out of Greece/Ireland/Portugal/Italy's problems? Well, last time Germany tried printing money it needed to pay its debts it unleashed a hyperinflation so fierce only Hitler could solve it. You want to tell the Germans it's ok to try it again?

So Italy squeaked its way into the Euro by tightening its belt. But it wouldn't really be fair to say they hit the buffet bar hard after joining. Despite being in a period of glacial growth usually peaking at about 1% for over a decade now, there were no stimulus packages here. Still, they couldn't get the debt level below 105%, and then America went and started a global recession and Italy's debt moved up to its current perilous level of 120%.

Italy have been relatively disciplined for about 15 years now, and yet their debt is higher than ever. One important, unavoidable reason is age. Italy, contrary to outdated stereotypes, has had one of the world's lowest birth rates (currently around 1.5 children/female) for decades. This has left a country chocked full of old people. Two problems there: old people don't work, and they do collect state pensions. For years now people have rang alarms in America about the costs of supporting the Baby Boomers when they retire. Well America's generational crunch will be a fraction of what Italy has had to live through thanks to immigration and a relatively high birth rate even after the end of the Baby Boom. The only good news for Italy is that, opposite of the US, the proportion of the economy the government will have to fork over has already peaked. Good news for my kids, at least.

Sunday, July 17, 2011

Dusting this off some

In case you hadn't noticed, Italy's been in the news a lot lately. Sure Prime Minister Berlusconi just lost one painful court decision (to the tune of €600 million) for corruption and is still on trial for orgies with underage prostitutes, but I guess that just isn't enough anymore to grab headlines in America anymore. So, we've stepped it up a notch. Lately smelly old Greece has been grabbing all the headlines, so Italy's thinking of really pulling out a showstopping number. They might go bust.

Bust would be bad. I have some friends and family who might be curious if it would be bad enough to chase me back home. Who knows. I'm optimistic, but really, who knows. If there's a default, several of the biggest Italian banks could go belly up- and there's no sign of there being anyone willing or able to bail them out. So think about the disaster the Lehman Bros. fold was, jam that in a country a fraction of the size of the US, and perhaps repeat the process several times. Well, that's the fear anyway.

So sit around the campfire kids, I'm going to tell the story about how Italy got here. No spin, just blow-by-blow. I think it's a fun story. Very Italian.

Ever since countries starting going bust around the EU (first Greece, then Ireland, then Portugal immediately followed by Greece again) people kept looking at Italy and waiting for a wobble that hadn't showed signs of coming yet. Italy has been living on thin ice for years. Their total debt is 120% of GDP. For reference- a 100% is considered really dangerous, and the US is at about 65% now [Edited- I originally wrote 80%. Sloppy fact checking department]. But Italy had been stable at that position for years. They showed no sign of being able to grow their way out of trouble, but whenever necessary, they tightened their belts.

Then the Italian government picked a really bad time to wobble, as Greece looked to be careening to a 3rd bailout- or worse. Berlusconi's 15-year long grip on Italy was weakening. He got pounded in 2 straight elections. So he and his coalition buddies start grumbling about tax cuts- something the market would absolutely not forgive if it expanded debt. But it was all political postureing. Despite the fact that both parties in the 2-party majority here would have wanted tax cuts, they were never going to get them. How? Finance Minister Giulio Tremonti is practically a 1-man show with the budget. Then Tremonti got sucked into Italy's latest corruption scandal (*sigh*). The markets started to freak.

Here's the problem with having a 120% debt. It's like having huge credit card bills and barely squeaking by with just covering the interest. Imagine the bank that issued the credit card suddenly declares it refuses to extend your credit and needs all the money you owe now. That would never happen with a credit card. If you can't pay the interest on your debt anymore the banks shrugs it off without noticing. If a country can't pay its interest payments, banks go bust. The banks have an incentive to understand sooner rather than later when a country is going bust long before it happens so they're not the ones left holding the hot potato. Soon everyone gets nervous, and starts avoiding the debt. The only offer of loans the state gets come at higher prices to offset the higher risk of default. So higher prices become higher debt, which lead to higher prices and... default!

The only way out of that spiral is to prove your a safe bet- i.e. you suck up huge cuts in the hope the simple act of austerity will soon lower prices to where they were before. Italy was already working on a belt-tightening measure when everything broke: it was ultimately considered half-convincing. Basically the idea of the austerity was appreciated, but not so much the fact that most all the cuts kick in during 2013, conveniently delayed until after scheduled elections. So their borrowing costs when down a smidge, but are still well above where they were a few months ago. As if the markets have said "No really, this is your last warning now!"

So my hopes: we squeak by here another year or two. Berlusconi will be gone after 2013, that much is sure, but all the rest is up in the air. Maybe we'll get lucky and get some competent management here. Hmm, why do I feel obligated to make some light-hearted joke intimating my doubt here?