tag:blogger.com,1999:blog-39497522024-03-13T22:34:06.527+01:00Italian Economy WatchUnknownnoreply@blogger.comBlogger295125tag:blogger.com,1999:blog-3949752.post-86949762693257341492014-08-17T13:10:00.003+02:002014-09-16T14:20:51.015+02:00The Italian Runaway TrainThere has been lot's of debate in the press and in academic circles over the last week or so about <a href="http://www.voxeu.org/article/italian-growth-new-recession-or-six-year-decline">whether Italy's latest contraction constitutes a triple dip recession</a> or simply a continuation of what's been going on over many many years. This is an interesting theoretical nicety, but in fact what is happening in Italy at the moment goes a lot further than problems faced by a recession dating committee. The real issue that arises in the context of the Euro Area at the moment is a far more specific one. Will the ECB do QE? And if it does when will it push the button? And what could happen if it doesn't. Perhaps a case study of the Italian case is worth the effort here. What is likely to happen to Italian debt if there is no ECB intervention soon? Let's take a look at the dynamics.<br />
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By now almost everyone and their grandad knows that Italy is back in recession following the 0.2% GDP contraction in the second quarter.<br />
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Not only did this result suggest that Italy was now in a triple dip recession (or a twenty year decline), it also meant that GDP was back at the same level it had in 2000, when the country entered the Euro currency union.<br />
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The problem is that Italy has an appallingly low trend GDP growth rate - possibly negative at this point - and nothing which has happened since the financial crisis ended suggests it is going to to improve radically anytime soon, in fact there are good reasons to think that growth could even deteriorate further.<br />
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In the first place Italy's working age population is now falling, and <a href="http://blogs.ft.com/ftdata/2014/02/27/renzis-hidden-problem-the-brain-drain/?infernofullcomment=1&SID=google">many young educated Italians are leaving to work elsewhere</a>. <br />
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And now, not only do we have the legacy then of high debt and low growth, a new problem has emerged: low inflation or even deflation. Italy's inflation has fallen to zero.<br />
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The combination of low inflation and low growth means that it is the evolution of nominal GDP that really matters now. Nominal GDP is non inflation corrected GDP (or GDP at current rather than constant prices). If inflation remains low or even becomes negative, then nominal GDP will hardly increase and may even continue to contract (as has happened in Japan). The result is bound to be that the gross government debt to GDP ratio rises above the 135.6% it hit in March.<br />
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One of the arguments frequently advanced about how this dynamic could be turned around would be for Italy to run a "large" primary budget surplus. Now the emphasis here is on <b>large</b> since the country has in fact run a primary surplus (income - expenditure before paying debt interest) since the early 1990s, but that hasn't stopped the weight of the debt climbing and climbing.<br />
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The IMF,<a href="http://www.imf.org/external/pubs/ft/fm/2013/01/pdf/fm1301.pdf"> in their 2013 Fiscal Monitor</a> outlined a scenario in which the obligations of heavily indebted European sovereigns first stabilise, and then fall to the 60% level targeted by the EU’s Fiscal Compact by 2030. It makes assumptions regarding interest rates, growth rates and related variables, and computes the cyclically adjusted primary budget surplus (the surplus exclusive of interest payments) consistent with this scenario. As they point out, the heavier the debt, the higher the interest rate and the slower the growth rate, the larger the requisite surplus. In fact they found that the average primary surplus required in the decade 2020-2030 was 5.6% for Ireland, 6.6% for Italy, 5.9% for Portugal, 4.0% for Spain, and 7.2% for Greece. <br />
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Is it plausible that Italy could run an average primary surplus of 6.6% of GDP over a decade? Hardly - in particular this implies that on average, every year, the government would be draining out 6.6% of GDP from domestic demand via taxation. Yet as I have noted many times, domestic demand is precisely the weak point in the Italian economy (secular stagnation, ageing population). <br />
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As Eichengreen and Panizzi (<a href="http://www.voxeu.org/article/can-large-primary-surpluses-solve-europe-s-debt-problem">who studied the plausibility of the IMF projections</a>) conclude:<br />
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"These are large primary surpluses. There are both political and economic reasons for questioning whether they are plausible.............History suggests that such behaviour, while not entirely unknown, is exceptional....... On balance, this analysis does not leave us optimistic that Europe’s crisis countries will be able to run primary budget surpluses as large and persistent as officially projected." </blockquote>
Italy's situation is to some extent replicated in other countries on the periphery (Ireland sovereign debt to GDP 124%, Portugal 132.9%, Spain 96.8% and Greece 174.1%, all numbers as of March 2014) since almost all official forecasts anticipate an imminent turnaround in the debt dynamic. If secular stagnation and ultra low inflation really set in this turnaround is going to be impossible to achieve and Europe's leaders will need to decide what to do about it. <br />
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Italy's debt now looks certain to climb towards 140% of GDP and beyond (maybe hitting that level as early as Q1 2015), meaning someone somewhere in the official sector should be able to recognize that it is not on a sustainable path. The so called AQRs (bank Assett Quality Reviews) are probably not going to generate too many surprises, but what about doing some realistic DSA's (Debt Sustainability Analyses)? <br />
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Cases like Greece and Portugal are to some extent containable from an EU perspective since the economies are small enough for EU leaders to engage in some sort of extend and pretend via low coupons and long horizon maturities. But Italy's debt is simply too big to be manageable in this way.<br />
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So EU leaders and the ECB now face a dilemma. Trying to make Italy comply with its EU deficit and debt obligations may well mean that the deficit comes down but in all probability the debt level will go up (given the weak nominal GDP effect). Not complying with them opens the possibility of stimulating slightly more growth (and possibly mildly stronger inflation) but naturally the debt level will rise. It's a sort of damned if I do and damned if I don't situation, since either way the debt burden rises.<br />
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From the point of view of the country's political leaders though, it is obvious that austerity today has costs (and few visible benefits) while deficit spending may bring some short term benefit at the price of hypothetical longer term debt issues. It shouldn't surprise us then if they go for the latter, especially since Japan's political leaders have been widely applauded for doing something similar.<br />
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Naturally, since the difficulties the onset of secular stagnation will produce for heavily indebted countries with ageing and shrinking workforces are not widely understood, hints that deficit objective relaxation calls are growing have not been well received everywhere. During the spring <a href="http://www.ft.com/intl/cms/s/0/d7b79578-a000-11e3-9c65-00144feab7de.html?siteedition=intl#axzz2v7QHse3y">the FT published</a> details of a document jointly issued by the German and Finnish finance ministries which strongly rebuked Brussels for easing austerity demands, citing in particular the additional flexibility given to France and Spain for reducing their budgets to within EU deficit limits. <br />
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“Since 2012, the commission has substantially changed the way it assesses whether a member state has taken ‘effective action’ to comply with [EU budget rules],” the memo states. “The recent methodological changes imply the risk of watering down the newly strengthened [rules] at its implementation stage.”<br />
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As might have been expected, Matteo Renzi was not slow in coming forward to seek similar treatment for his country (See "<a href="http://www.ft.com/intl/cms/s/0/9472a5da-c659-11e3-ba0e-00144feabdc0.html?siteedition=intl#axzz2z7srnzJ8">Italy request to push back budget targets dismays Brussels</a>" FT April 17). According to the newspaper the country's finance minister, Pier Carlo Padoan, sent a formal written request to the commission on 16 April seeking authorisation for a change in objectives. Citing the “severe recession” that set Italy back in 2012 and 2013, Mr Padoan wrote that Italy wanted to “<b>deviate temporarily from the budget targets</b>” and that because of “<b>exceptional circumstances</b>” (my emphasis throughout) the government had decided to accelerate the payment of arrears owed by the public to the private sector by €13bn, which would increase the debt to GDP ratio in 2014. The trouble is that these "temporary factors" and "exceptional conditions" seem to arise with a predictable regularity in Italy's case. The country is currently aiming for a balanced structural budget in 2016 rather than 2015 as agreed with Mario Monti’s technocrat government in 2012. A year earlier, then prime minister Silvio Berlusconi had promised a balanced structural budget by 2013.<br />
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<b>Enter Mario Draghi</b><br />
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The relationship between Mario Draghi and Matteo Renzi has long been a source of speculation and gossip. Shortly after he came to office in February following a kind of palace revolution inside his own party whereby the incumbent Prime Minister - Enrico Letta - was unceremoniously defenestrated the Financial Times Brussels correspondent even published a post on an FT blog with the rather direct title: <a href="http://blogs.ft.com/the-world/2014/02/does-renzi-owe-his-job-to-draghi/">Does Renzi owe his job to Draghi?</a> <br />
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The gist of the article was an attempt to establish some sort of connection between Matteo Renzi's arrival in office and the the outcome of the then recent German Constitutional Court ruling which put into question the viability of the central bank's OMT (Outright Monetary Transactions) programme. Spiegel's hypothesis was that the driving force for some kind of "unholy alliance" between the two of them lay in Draghi's interest in getting prime minister Letta out of office before pressure from within Germany about maintaining open the offer of a now legally questionable OMT programme to an Italy which was visibly enjoying cheaper bond yields - but was manifestly not advancing with its reform programme - became too strong to withstand.<br />
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"Do last week’s German constitutional court ruling lambasting – but failing to overturn – the ECB’s crisis-fighting bond-buying programme and Matteo Renzi’s ousting of Italy’s prime minister Enrico Letta have anything in common? In the view of many ECB critics, particularly in Berlin, the two are not only related, but one may have caused the other."<br />
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"In the view of many German critics, there has been no serious effort by the Italian government – be it in the fading months of Mario Monti’s premiership or during Enrico Letta’s foreshortened tenure – to undertake major economic reforms since ECB boss Mario Draghi first announced he would do “whatever it takes” to save the euro in July 2012."</blockquote>
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The key part of the background here is that the German court ruling effectively left OMT - which only ever had a virtual existence and was increasingly seen as an empty bluff since it was clear no one was going to accept the conditionality side - deader than that infamous dead duck. Karlsruhe's objection to the existing bond buying programme was that it went beyond the ECB's mandate since directly financing government debt is prohibited under Maastricht, and the objective of OMT was to help governments finance at an affordable price. Since break-up risk - which could have offered an alternative justification for OMT - is for the moment off the table, OMT lacked definitive legal justification and in practical terms the emperor visibly had no clothes. It was just a question of how long the markets needed to wake up to the fact.<br />
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So it was imperative to find some other justification for the initiation of a bond purchases programme should one be needed. Then along came deflation. The important point is that if a programme of bond purchases is implemented as a form of QE it will differ from the earlier OMT programme in terms of the justification offered. Any QE programme introduced to combat deflation would be implemented as part of an attempt to attain price stability, an objective which does lie within the central bank mandate. Another key difference is that if QE is launched and involves bond purchases the bank will buy bonds from ALL countries in the monetary union (according to their weight in Euro Area GDP), which brings us to the third difference from OMT: there will be no conditionality attached. Given this it became a "high risk" operation and it was clear that Mario Draghi needed someone else at Italy's helm if he wanted to be able get the Germans on board with QE, someone who could convince them Italy would enact the required reforms. Enter Matteo Renzi. <br />
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Now fast forward to August, and we find the former mayor of Florence who had surged to office on the back of promises to enact aggressive labour market reforms, a battery of spending and tax cuts and significant privatizations has been strong on talking and very weak on action. Something which is not uncommon in Italy, but people had expected more. They thought this time was different.<br />
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Mario Draghi's irritation with the situation was visible <a href="http://www.ft.com/intl/cms/s/0/8f677018-2066-11e4-b8f4-00144feabdc0.html#axzz3AXl5FSh2">at the August ECB press conference</a>. When asked by one of the journalists why Italy had fallen back into recession he could hardly contain himself, and was unusually direct in saying a lack of structural reforms was holding the country back and hampering a return to growth. The reference to Renzi was evident.<br />
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One week later <a href="http://www.reuters.com/article/2014/08/13/us-italy-economy-idUSKBN0GD19N20140813">the two met</a>, in what they had obviously hoped would be a secret meeting but Italy being Italy the press went along for the ride. While no details of what happened at this meeting have transpired it is pretty clear Draghi will have used the opportunity to read his fellow countryman the riot act. Italy has been full of talk about some kind of Troika intervention, but this is most unlikely, and Renzi made it pretty clear <a href="http://www.ft.com/intl/cms/s/0/3e790e94-208b-11e4-890a-00144feabdc0.html#axzz3AXl5FSh2">in his Financial Times interview</a> that he personally wouldn't be asking for one.<br />
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When asked why Italy's reform pace seemed so slow he rejected Draghi's suggestion that the EU should intervene in countries where reforms were not being implemented fast enough. “I agree with Draghi when he says that Italy needs to make reforms but how we are going to do them I will decide, not the Troika, not the ECB, not the European Commission,” he said. “I will do the reforms myself because Italy does not need someone else to explain what to do."<br />
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The problem is that with the debt dynamics we have seen above the one thing Italy doesn't have at this point is time. It isn't a problem of the impact of a so called "debt snowball" as interest rate payments send debt levels spiraling upwards. If anything it's worse. Mario Draghi can, in theory, contain the debt interest problem, and if needs be along with it the capital repayments schedule. But the problem Italy has at the moment is one of the credibility of its debt, of the country being able to convincingly argue its trajectory is sustainable, of being able to convince the Germans that if the ECB were to buy bonds these they could EVER be redeemed.<br />
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While Renzi has waxed eloquently about transforming Italy, buoyed on by the results of the European Parliament elections he seems more concerned with pushing through electoral reform - which is obviously needed but is not perhaps as pressing as the growth and debt problem - leaving the suspicion that he is more interested in getting re-elected than anything else. Indeed the fact that he needs the support of the discredited former Prime Minister Silvio Berlusconi to get the reform through with any kind of urgency (see <a href="http://www.newsweek.com/italy-slips-back-recession-new-pm-seeks-berlusconis-help-263267">Italy Slips Back Into Recession, As New PM seeks Berlusconi's Help</a>) has lead critics of the two "institutional parties" to suggest the reform may be more about getting rid of newcomers like Beppe Grillo's Five Star movement than anything else (see <a href="http://www.thelocal.it/20140725/government-lays-bear-trap-for-senate-reform">Renzi slammed for "coup" over senate changes</a>) .<br />
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To date Renzi's government - which is almost operating outside real historical time in terms of economic issues - has made little progress on the sort of reforms which might help the country recover some kind of growth, like those to the judicial system and the labor market. The only measure that could be considered vaguely "pro-growth" that his government has enacted was the 80 euro bonus delivered to low-wage workers hasn't boosted the economy as its proponents claimed. The measure seems more cosmetic - comparable with José Luis Zapatero's ridiculous "Plan E" in Spain - and only reinforces the impression of politicians fiddling while Rome burns. The business lobby Confcommercio, which was highly critical of the measure, <a href="http://www.nwitimes.com/news/national/europe/lobby-govt-bonus-hasn-t-boosted-italy-s-economy/article_70fa6911-6c79-548a-bd92-83641afc2772.html">calculated that consumption was boosted by just 0.1% in June</a>, the first month in which the tax relief was operative. In their press release they said Italian families were holding back from shopping “because their uncertainty about the future was stronger than the actual increase in funds in their pockets”.<br />
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Despite this Prime Minister Renzi continues to insist that his government's economic strategy is sound and will lift the country out of crisis.<a href="https://uk.news.yahoo.com/italian-pm-renzi-defies-critics-recession-returns-201217933--business.html#TDAhB4E">In a lengthy interview broadcast on La7 television</a> following the announcement of the GDP results, Renzi said that his government was determined to get the economy back on track, but in due course. "We will work better and harder, but I promised to change direction, not to change the universe in three months time," Renzi said, adding that only a "comic book superhero" could turn around the economy in a matter of months. "Calmly, serenely, we are taking this country by the hand and pulling it out of the crisis," Renzi told listeners.<br />
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The problem outside observers are having is not in seeing the complete turnaround - Renzi is right here, this involves a long painful road - but in identifying the first baby steps that are being taken.<br />
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And fears about Mr Renzi’s grasp on Italy’s finances were fanned again last week when spending review commissioner <a href="http://it.wikipedia.org/wiki/Carlo_Cottarelli">Carlo Cottarelli</a> highlighted the tensions which existed in the government over the prime minister’s spending plans. In <a href="http://revisionedellaspesa.gov.it/blog.html">a post on his blog</a>, Mr Cottarelli - who was appointed by Letta and was previously <a href="https://www.imf.org/external/np/bio/eng/ccot.htm">Director of the Fiscal Affairs Department at the IMF</a> - said that earlier savings were already being used by parliament for other expenditure, meaning that in the longer term they could not be used to reduce taxes on employment (which is what they were intended for).<br />
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Renzi normally responds to critics that all points of view are valid but 11 million Italians think differently, in a clear reference to what he perceives to be his electoral support. But even this will eventually wane if progress is not seen to be made on the economy. <a href="http://www.ft.com/intl/cms/s/0/eaaeffe0-1d7d-11e4-8f0c-00144feabdc0.html?siteedition=intl#axzz3AXl5FSh2">The FT quotes</a> Wolfango Piccoli, analyst at Rome-based think-tank Teneo, to the following effect: “As prime minister Matteo Renzi struggles to make progress on political reform, it is becoming increasingly clear that his government lacks an original and coherent plan for the economy,” <br />
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To add insult to injury, more bureaucratic delays mean that the treasury will not hit its target to raise €12bn from privatizations this year. There are also concerns about the outcome of the European Central Bank’s stress tests and asset quality review of the country’s leading banks. Bankers point out that if an Italian bank needs a bail out the state’s coffers will not easily be able to support it. Of course here we have a mighty instrument which Draghi can use to twist Renzi's arm.<br />
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Another issue is labour market reform. The controversial <a href="http://www.gazzettadelsud.it/news/english/104078/-Article-18-just-an-ideological-totem--says-Renzi.html">Article 18 of Italy's workers statute is "just a symbol"</a>, and "debating it is a pointless exercise", Renzi told State broadcaster RAI 3 last week. The comments came after Interior Minister Angelino Alfano, who comes from the New Center Right (NCD) party, called for its abolition. Article 18 of the 1970 Workers Statue is a law that forbids companies with over 15 employees from firing people without just cause. <br />
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The Italian Prime Ministers reluctance to tackle the labour market issue is understandable. Any attempt to really change Italian labour law would be deeply unpopular on the left (and even among many in his own party) and a direct clash with Italy's unions would surely cost him votes if his plan is to hold elections after passing a new electoral law. More fiddling while Rome Burns.<br />
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<b>So Which Way For The ECB?</b><br />
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Evidently members of the EU Commission, ECB governing council members, and senior political leaders in Berlin, Amsterdam or Paris are neither theoreticians nor intellectuals. The secular stagnation hypothesis is at this point more akin to a theoretical research strategy than a workable template for policy-making, and policymakers are understandably reluctant to take decisions on the basis of what is still largely a hypothesis. <a href="http://www.voxeu.org/article/secular-stagnation-facts-causes-and-cures-new-vox-ebook">As the editors of a recent book on the topic</a> put it in their introduction: "Secular stagnation proved illusory after the Great Depression. It may well prove to be so after the Great Recession – it is still too early to tell. Uncertainty, however, is no excuse for inactivity. Most actions are no-regret policies anyway". As they suggest the risks here are far from evenly balanced. If countries like Japan, Italy and Portugal are suffering from some local variant of one common pathology, then normal solutions are unlikely to work, and matters can deteriorate fast.<br />
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Naturally the ECB can go down the Abenomics path, and institute large scale sovereign bond purchases even while the Commission turns an increasingly blind eye to higher deficit spending at the country level. But it is far from clear that Abenomics works (see <a href="http://edwardhughtoo.blogspot.com.es/2014/08/abenomics-what-could-possibly-go-wrong.html">here</a>) and if it doesn't what happens to all the accumulated debt?<br />
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On the other hand time always has a cost. Letting things drift further means letting debt levels rise, and risking testing market patience and this becomes especially important in the cases of Italy and Portugal. The longer time passes the more difficult it is going to be for anyone to convince themselves that the debt of these countries is sustainable.<br />
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So there may come a point after which the Germans simply will not allow Draghi to buy Italian bonds without a prior haircut. OK, they've said they won't do more PSI, but they've said a lot of things, and the cost of irritating investors is limited when you have a regional current account surplus and a central bank buying bonds.<br />
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Maybe the costs of the Euro "widowmaker" trade will be borne by all those eager bond purchasers who thought nothing could possibly go wrong. I am sure German politicians would decide a loss of credibility on PSI would be less costly to them than getting German taxpayers on the hook for current Italian debt levels. Especially in a country <a href="http://in.reuters.com/article/2014/08/14/germany-economy-debt-idINL6N0QK1PN20140814">where they are now proudly announcing</a> they have reduced government debt for the first time in more than 50 years. So in this case, maybe the turkeys just did vote for Xmas.<br />
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The thing is, despite the meeting between Draghi and Renzi (who may also be a turkey by Xmas) nothing substantial is going to happen in Italy. The government is under no pressure to ask for help (and doesn't even feel it needs it), and Draghi won't act before things change. Gridlock - with rising debt. <br />
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Naturally in the short term the “Mario Draghi ultimately has my back” feeling will still prevail, but with markets continuing to finance debt levels that any official study will soon have to recognize as unsustainable lack of proactive policies from the ECB will only fuel concerns that the size of the pill may become just too big for the bank to persuade Germany comfortably swallow, leaving the specter of private sector involvement to once more rear its ugly head. How do you tell people who have just sacrificed hard to get their debt under control that they are now about to help "pardon" 50% of someone else's. It simply doesn't make sense.<br />
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<br />
These arguments are developed at greater length in my new book "<a href="http://www.amazon.com/The-Euro-Crisis-Really-Over/dp/1502343436/ref=sr_1_2?ie=UTF8&qid=1410776947&sr=8-2&keywords=edward+hugh"><b>Is The Euro Crisis Really 0ver?</b></a> - <b>will doing whatever it takes be enough</b>" - on sale in various formats - <a href="http://www.amazon.com/Euro-Crisis-Really-Over-Whatever-ebook/dp/B00NKA6PN8/ref=sr_1_2?s=digital-text&ie=UTF8&qid=1410812161&sr=1-2&keywords=edward+hugh">including Kindle</a> - at Amazon.<br />
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<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-3949752.post-50994838791203122492014-05-18T13:23:00.001+02:002014-05-18T14:07:33.377+02:00On The Trail Of Italian DebtLooking for trends and correlations in that landslide of economic data which arrives, day in and day out, on our desks is normally something akin to trying to find a needle in a very large and raggedy haystack. From time to time, however, some things are just to obvious not to be noticed, like the ever rising levels of debt on the EU periphery and the growing demand from political leaders there for some kind of QE type initiative from the European central bank, for example. Sure, there is no obvious causal connecting here - the missing "middle term" linking the two would probably be all that ongoing deflation risk - but the inability of governments to contain their debt levels is a consequence of having low growth and low inflation, as is the wish being ever more insistently expressed by Southern Europe's political leaders that the ECB were more like the Bank of Japan.<br />
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In this context the latest batch of Euro Area GDP numbers must have come like a bucket of ice cold water thrown across the luke warm recovery hopes of policymakers in Frankfurt, Brussels and Berlin. Only the German economy put in a really impressive performance (0.8% quarter on quarter). Spain's economy also did well, but the 0.4% quarterly growth failed to convince due to the fact that the main influences on the number were a 1.2% fall in imports and a 0.4% negative inflation calculation (see <a href="http://spaineconomy.blogspot.com.es/2014/04/spains-recovery-continues-in-q1-2014.html">my analysis here</a>).<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgUHL95Bf7szlndkPxLjcLqy0r7NSNm9eNd-Y1ksIZEKNK26EhzplE6mbR51A_FnQjoNUWSeGpKPICVPc8BVSpe2KRKiGHYIoOs9cIQeYNEtHo3xHN6ROVq0QPBv1mc1gGBZJY78w/s1600/Italy+Constant+Price+GDP.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgUHL95Bf7szlndkPxLjcLqy0r7NSNm9eNd-Y1ksIZEKNK26EhzplE6mbR51A_FnQjoNUWSeGpKPICVPc8BVSpe2KRKiGHYIoOs9cIQeYNEtHo3xHN6ROVq0QPBv1mc1gGBZJY78w/s1600/Italy+Constant+Price+GDP.png" height="188" width="320" /></a></div>
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France's economy stagnated, but more worryingly for policymakers core Europe countries like Finland (minus 0.4 q-o-q) and the Netherlands (minus 1.4%) failed to shake off their long running recessionary drag, while periphery growth laggards like Portugal (minus 0.7%) and Italy (minus 0.1%) fell back again into negative growth territory. Clearly the Euro Area seems <a href="http://krugman.blogs.nytimes.com/2014/05/17/secular-stagnation-in-the-euro-area/">to be stuck in some form of secular stagnation</a>, a feeling which is only confirmed by the very low inflation levels we are seeing and reinforced by the fact that both Portugal and Italy have suffered from chronically low growth rates since the start of the century.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgcMro70KoLP0gkYjz-RufZJdewDFW1YVWUJ_P1kSQyiWrUROJkPpeSnI1toQ110IB_EOw0mO94Zz8SD9Cb0u8zVactJiGmjdiDScct_byVsU2Hs_oPSN_3nKCs6xkNEXn8Gq1AIA/s1600/italy+long+term+GDP.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgcMro70KoLP0gkYjz-RufZJdewDFW1YVWUJ_P1kSQyiWrUROJkPpeSnI1toQ110IB_EOw0mO94Zz8SD9Cb0u8zVactJiGmjdiDScct_byVsU2Hs_oPSN_3nKCs6xkNEXn8Gq1AIA/s1600/italy+long+term+GDP.png" height="161" width="320" /></a></div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg1ODcyO5t3UL73_be9XuHw0Ya-EspilmjM1TaXo3quzcN14HR7HcFENQ3Nczw9m8IHyQPAnw_UgD2PVTsc4gxGHQiNNzeFwL4pe1xt3XoFNP1bBDKWDNhc0rM5QF3722FpFfxqbw/s1600/Portugal+long+term+growth.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg1ODcyO5t3UL73_be9XuHw0Ya-EspilmjM1TaXo3quzcN14HR7HcFENQ3Nczw9m8IHyQPAnw_UgD2PVTsc4gxGHQiNNzeFwL4pe1xt3XoFNP1bBDKWDNhc0rM5QF3722FpFfxqbw/s1600/Portugal+long+term+growth.png" height="197" width="320" /></a></div>
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Nothing which has happened since the crisis suggests this low trend growth rate is going to to improve radically, in fact there are good reasons to think that trend growth might even deteriorate further: both countries have higher debt loads (public and private combined) than when they entered the crisis, and in both cases working age populations have now started to decline. (See an excellent review of the Portugal situation by Valter Martins <a href="http://edwardhughtoo.blogspot.com.es/search?updated-min=2013-01-01T00:00:00-08:00&updated-max=2014-01-01T00:00:00-08:00&max-results=20">here</a> and <a href="http://demographymatters.blogspot.com.es/2013_05_01_archive.html">here</a>). <br />
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Not only do we have a legacy then of high debt and low growth, a new problem has emerged: low inflation or even deflation. Italy's inflation has fallen to very low levels, while Portugal now has experienced 3 consecutive months of negative annual inflation.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjFSfUxRzgA3iZTWdV8h-4C-raPCLhDCEMixO7YybXc-svDd1KtmhdX7oTyylVADkHco4K3eQBsx1LE3PGkz8rRnkazYsu6BTc-zNYUPJQFM6L3zu7FUdJd1r0VoTyaQShvoP5v5A/s1600/italy+cpi+y-o-y.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjFSfUxRzgA3iZTWdV8h-4C-raPCLhDCEMixO7YybXc-svDd1KtmhdX7oTyylVADkHco4K3eQBsx1LE3PGkz8rRnkazYsu6BTc-zNYUPJQFM6L3zu7FUdJd1r0VoTyaQShvoP5v5A/s1600/italy+cpi+y-o-y.png" height="179" width="320" /></a></div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgzWqhZD7PkmzIj7nCE6a-XTf0rf5V6ODGGufF0Edp8y64e_RpjjtteW4c9D_dhr7ouog2nXlx5BMXRZ-6z3kp82LgNrRVYkuVW69eedEdM-epXwqCfvy_Y0ZiJ-01rN5QkM50xTg/s1600/portugal+CPI+YoY.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgzWqhZD7PkmzIj7nCE6a-XTf0rf5V6ODGGufF0Edp8y64e_RpjjtteW4c9D_dhr7ouog2nXlx5BMXRZ-6z3kp82LgNrRVYkuVW69eedEdM-epXwqCfvy_Y0ZiJ-01rN5QkM50xTg/s1600/portugal+CPI+YoY.png" height="179" width="320" /></a></div>
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The combination of low inflation and low growth means that it is the evolution of nominal GDP that really matters now. Nominal GDP is non inflation corrected GDP (or GDP at current rather than constant prices). If inflation remains low or even becomes negative, then nominal GDP will hardly increase and may even contract (as has happened in Japan). This phenomenon has already started to make itself felt in Spain, as the following chart from the Spanish statistics office makes plain.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg2NFmHpkwi1JjB1fi-MLYB8jTilPr37EbVcWUoaR3erC0kE7TepdZPZe5iIFUDL3iTtCZADIu4po-RAxdbzD7RkH9kVDtPpOacVtWCs4xivaBTrMQfcmNUI3lMRbXDHT5uOZYzag/s1600/2014-04-26_073424.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg2NFmHpkwi1JjB1fi-MLYB8jTilPr37EbVcWUoaR3erC0kE7TepdZPZe5iIFUDL3iTtCZADIu4po-RAxdbzD7RkH9kVDtPpOacVtWCs4xivaBTrMQfcmNUI3lMRbXDHT5uOZYzag/s1600/2014-04-26_073424.png" height="194" width="320" /></a></div>
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We don't have any detailed data for Spain's Q1 2014 performance yet beyond the Bank of Spain initial estimates, but if this estimate is confirmed by the National Statistics Office then it is unlikely than nominal GDP at the end of March was much above the level it was at last June, despite the recovery in economic activity. Which is one of the reasons that Spain's debt to GDP level has been rising so rapidly in the last 12 months. Naturally something similar has been happening to Italian debt, which rose from 127% of GDP in December 2012 to 132.6% GDP in December 2013, despite the fact the country only had an annual fiscal deficit of only 3% of GDP. Italy's nominal GDP fell in both 2012 and 2013, largely due to the sharp drop in economic activity. Nominal GDP may continue to fall in 2014, but this time because the GDP deflator is negative. If this happens the debt level will continue to rise confounding hopes for a turnaround in the dynamic.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhQUEXaVA1Fr28gxZteL0BahCj5Hs5LaBnxo98peHjWcTBcZltpOCmi5gnCFL_1pfQf7H9aOHguJnrkgbIiZ0qYKrKypZsvELSIE5riq5Qu_r7J5VEbXfHfE3ymIi_hvcVVoLH15g/s1600/Italy+Gross+Government+Debt.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhQUEXaVA1Fr28gxZteL0BahCj5Hs5LaBnxo98peHjWcTBcZltpOCmi5gnCFL_1pfQf7H9aOHguJnrkgbIiZ0qYKrKypZsvELSIE5riq5Qu_r7J5VEbXfHfE3ymIi_hvcVVoLH15g/s1600/Italy+Gross+Government+Debt.png" height="184" width="320" /></a></div>
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Italy's situation is to some extent replicated in other countries on the periphery (Ireland sovereign debt to GDP 124%, Portugal 129%, Spain 93.9% and Greece 175%) since almost all official forecasts anticipate an imminent turnaround in the debt dynamic. If secular stagnation and ultra low inflation really set in this turnaround is going to be impossible to achieve and Europe's leaders will need to decide what to do about it. <br />
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Italy is a good case in point here, since if debt were to climb towards 140% of GDP and beyond, then someone somewhere would surely have to officially recognize that it was not on a sustainable path. Cases like Greece and Portugal are to some extent manageable from an EU perspective since the economies are small enough for EU leaders to engage in some sort of extend and pretend via low coupons and long horizon maturities. But Italy's debt is simply too big to be manageable in this way.<br />
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So Italy's government faces a dilemma. Complying with its EU deficit and debt obligations may well mean that the deficit comes down but in all probability the debt level will go up (given the weak nominal GDP effect). Not complying with them opens the possibility to slightly more growth (and possibly stronger inflation) but naturally the debt level will rise. It's a sort of damned if I do and damned if I don't situation, since either way the debt burden rises.<br />
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From the point of view of the country's political leaders though, it is obvious that austerity today has costs (and few visible benefits) while deficit spending may bring some short term benefit at the price of hypothetical longer term debt issues. It shouldn't surprise us then if they go for the latter, especially since Japan's political leaders have been widely applauded for doing something similar. <br />
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Naturally, since the difficulties the onset of secular stagnation will produce for heavily indebted countries with ageing and shrinking workforces are not widely understood, hints that deficit objective relaxation calls are growing have not been well received everywhere. <a href="http://www.ft.com/intl/cms/s/0/d7b79578-a000-11e3-9c65-00144feab7de.html?siteedition=intl#axzz2v7QHse3y">The FT published details recently of a document</a> jointly issued by the German and Finnish finance ministries which strongly rebuked Brussels for easing austerity demands, citing in particular the additional flexibility given to France and Spain for reducing their budgets to within EU deficit limits. Although given the latest performance results for the Dutch and especially the Finnish economy ("<a href="http://www.reuters.com/article/2014/05/11/us-finland-economy-insight-idUSBREA4A02T20140511">Once Europe's lead preacher of budget prudence, Finland loses righteousness</a>"), Germany may find itself increasingly out on a limb if it maintains this posture.<br />
<blockquote class="tr_bq">
“Since 2012, the commission has substantially changed the way it assesses whether a member state has taken ‘effective action’ to comply with [EU budget rules],” the memo states. “The recent methodological changes imply the risk of watering down the newly strengthened [rules] at its implementation stage.”</blockquote>
As might have been expected, Matteo Renzi has not been slow in coming forward to seek similar treatment for his country (See "<a href="http://www.ft.com/intl/cms/s/0/9472a5da-c659-11e3-ba0e-00144feabdc0.html?siteedition=intl#axzz2z7srnzJ8">Italy request to push back budget targets dismays Brussels</a>" FT April 17). According to the newspaper the country's finance minister, Pier Carlo Padoan, sent a formal written request to the commission on 16 April seeking authorisation for a change in objectives. Citing the “severe recession” that set Italy back in 2012 and 2013, Mr Padoan wrote that Italy wanted to “<b>deviate temporarily</b> from the budget targets” and that because of “<b>exceptional circumstances</b>” (my emphasis throughout) the government had decided to accelerate the payment of arrears owed by the public to the private sector by €13bn, which would increase the debt to GDP ratio in 2014.
The trouble is that these "temporary factors" and "exceptional conditions" seem to arise with a predictable regularity in Italy's case. The country is currently aiming for a balanced structural budget in 2016 rather than 2015 as agreed with Mario Monti’s technocrat government in 2012. A year earlier, then prime minister Silvio Berlusconi had promised a balanced structural budget by 2013.
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<br />
Naturally Brussels was not amused (“Brussels is very upset,” one senior Italian official told the FT) and issued a statement to the effect that Italy's economic woes continued to require strict monitoring and "strong policy action".Such findings form part of the EU's new system of economic policy coordination and are aimed at preventing a repeat of the euro zone's debt crisis. The system requires governments to undergo repeated scrutiny of their economic performance to determine if there are economic trends and policies that are sowing the seeds of future problems.<br />
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But as Mathew Dalton pointed out in an article in the WSJ (<a href="http://online.wsj.com/news/articles/SB10001424052702304788404579521831361017144?tesla=y&mg=reno64-wsj">Italy's Plea for Leeway Puts Brussels in a Bind</a>) the problem facing Berlin and the EU Commission is far from straightforward.
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<blockquote class="tr_bq">
The problem of Italy's debt is shaping up to be a key test of the European Union's complicated new system for controlling the finances of its member states. </blockquote>
<blockquote>
The new budget rules are proving to be a source of conflict, pitting harder-line countries such as Germany and the Netherlands against broad swaths of Southern Europe that want more leeway on their budgets.
Standing in the middle is the European Commission, the EU's executive arm, which has gained stronger authority to enforce the new rules.<br />
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Now it faces a crucial decision: Does it insist on a tough enforcement of the rules that could potentially plunge the Italian economy back into recession? Or does it give Rome some flexibility and risk undermining the new system that Brussels fought hard to establish to prevent a repeat of the region's debt crisis?
</blockquote>
As Dalton points out the Commission will be wary of enforcing any rule which may undermine Matteo Renzi's credibility, aware as they will be that most of the alternatives are likely to be (from their point of view) far worse. Further, aside from the likely strong performance of Beppe Grillo in the forthcoming EU parliament elections the country is becoming increasingly eurosceptic (<a href="http://www.opendemocracy.net/can-europe-make-it/euro-elections-you-tell-us/jacopo-barbati/italy-is-quickly-turning-from-one-of-most-pro-eu-countries-to-one-">Italy turns from one of the most pro-EU countries, to the most eurosceptic</a> ).<br />
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<h3>
<b>Secular Stagnation or No Secular Stagnation, That Is The Question</b> </h3>
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Evidently members of the EU Commission, ECB governing council members, or senior political leaders in Berlin, Amsterdam or Paris are neither theoreticians nor intellectuals. Secular stagnation is at this point more akin to a theoretical research strategy than a template for policymaking, and policymakers are understandably reluctant to take decisions on the basis of what is still largely a hypothesis. But the risks here are far from evenly balanced. If countries like Japan, Italy and Portugal are suffering from some local variant of one common pathology, then normal solutions are unlikely to work, and matters can deteriorate fast.<br />
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Naturally the ECB can go down the Abenomics path, and institute large scale sovereign bond purchases even while the Commission turns an increasingly blind eye to higher deficit spending at the country level. But <a href="http://japanjapan.blogspot.com.es/2014/03/the-growing-mess-which-will-be-left.html">it is far from clear that Abenomics work</a>s (or <a href="http://japanjapan.blogspot.com.es/2013/05/the-b-e-of-economics.html">here</a>, or <a href="http://japanjapan.blogspot.com.es/2013/05/the-real-experiment-that-is-being.html">here</a>) and if it doesn't what happens to all the accumulated debt?<br />
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Basically we are at the point where no easy answers are available, and where the best step we could take would be to try to start asking some of the right questions. Will, for example, unconventional Keynesian policy work as advertised in the case of declining-working-age-population induced secular stagnation? Paul Krugman <a href="http://krugman.blogs.nytimes.com/2014/05/17/secular-stagnation-in-the-euro-area/">seems to assume it can</a>, when he asks himself whether there are "structural changes in Europe that arguably will lead to persistently lower demand unless offset by policy?" Exactly which policy/policies are we talking about here?<br />
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Larry Summers appears to take a similar view (<a href="http://larrysummers.com/commentary/financial-times-columns/why-stagnation-might-prove-to-be-the-new-normal/">Why stagnation might prove to be the new normal</a>). But both economists are far from being unambiguous about the situation. Summers concludes his piece by saying that "the risk of financial instability" (being provoked by sustained non-conventional measures like Abenomics) "provides yet another reason why preempting structural stagnation is so profoundly important".<br />
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Europe, unfortunately has now been left to drift well beyond that early "preemptive" stage.
Paul Krugman concludes his review (<a href="http://krugman.blogs.nytimes.com/2014/04/09/stagnation-without-end-amen-wonkish/?_php=true&_type=blogs&_r=0">Stagnation Without End, Amen</a>) of what has to be the most substantial examination to date of the theoretical issues involved (Gauti Eggertsson and Neil Mehrotra's "<a href="http://www.econ.brown.edu/fac/Gauti_Eggertsson/papers/Eggertsson_Mehrotra.pdf">A Model of Secular Stagnation</a>") by asking himself "whether there is a possibility of sustaining the economy with permanent fiscal expansion". Naturally, the answer is important since if there isn't the validity of the whole Keynesian model which PK himself has been working with would be called into question. A point which is entirely lost on those who reject the secular stagnation hypothesis outright (I won't let mere facts get in my way) for inbuilt ideological reasons. As I say, finding a way forward to manage this problem is very much a matter of which questions you allow yourself to ask.
Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-3949752.post-36074805810352230262014-02-27T08:38:00.000+01:002014-03-06T08:38:47.782+01:00Could Mario Draghi Implementing QE At The ECB Possibly Help Matteo Renzi Raise the Italian Deficit?What a convoluted title! Still, the lack of formal elegance might just be compensated for by its communicative efficacy. The aim of the above header is to link two names in people's minds, both of them Italian: Mario Draghi and Matteo Renzi. Naturally the idea is not original, the FT's Peter Spiegel recently published an entire blog post ( <a href="http://blogs.ft.com/the-world/2014/02/does-renzi-owe-his-job-to-draghi/">Does Renzi owe his job to Draghi?</a>) trying to establish some sort of connection between the arrival in office of Italy's Matteo Renzi and the recent German Constitutional Court ruling - in the process casting the central bank President in the role of midwife. Indeed, according to the FT, Italy itself is currently rife with rumours about what might actually lie behind Renzi's meteoric rise, and again the role alloted to Mr Draghi seems to be rather more than an incidental one.<br />
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But this post is not about rumour, nor is it about speculation - beyond, that is, speculation about what the ECB might do in its campaign to keep the Eurozone deflation menace at bay. Rather than conspiracies (real or imagined) it is about coincidences and the role they so often play in shaping events and outcomes. In this sense the fact that Mario Renzi took over the helm of government in Italy just a short time after the German Constitutional Court ruled on the ECB's Outright Monetary Transactions (OMT) programme has real potential.<br />
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What we could call Spiegel's hypothesis suggests the driving force for the "unholy alliance" which may or may not have been forged between Matteo Renzi and Mario Draghi would be found in the latter's interest in getting prime minister Letta out of office before pressure from within Germany about maintaining open the offer of a legally questionable OMT programme to an Italy which was enjoying cheaper bond yields but was manifestly not advancing with its reform programme became too strong to withstand.<br />
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<i><br /></i>
<i>"Do last week’s German constitutional court ruling lambasting – but failing to overturn – the ECB’s crisis-fighting bond-buying programme and Matteo Renzi’s ousting of Italy’s prime minister Enrico Letta have anything in common? In the view of many ECB critics, particularly in Berlin, the two are not only related, but one may have caused the other."</i><br />
<i><br /></i>
<i>"The German government has always had a bit of a love/hate relationship with the bond market throughout the four-year-old eurozone crisis. On the one hand, it regarded sovereign bond holders as greedy opportunists looking for German taxpayers to bail out their bad bets. On the other hand, those same traders were a useful tool to keep pressure on wayward governments – particularly Italy – that were in dire need of economic reforms to spur growth."</i><br />
<i><br /></i>
<i>"In the view of many German critics, there has been no serious effort by the Italian government – be it in the fading months of Mario Monti’s premiership or during Enrico Letta’s foreshortened tenure – to undertake major economic reforms since ECB boss Mario Draghi first announced he would do “whatever it takes” to save the euro in July 2012."</i><br />
<i><br /></i>
<i>"The bond-buying progamme that the German constitutional court grumbled about last week – known as Outright Monetary Transactions – was the product of that speech 18 months ago and has kept the crisis at bay ever since, helping keep Italian borrowing costs near pre-crisis levels."</i></blockquote>
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Leaving aside the problem of mechanism - how could Mr Draghi or anyone else have stirred up participants in the Italian Democratic Party's primary election - the potential synergy between the two developments (the Karlsruhe ruling and the new government in Italy) is more than evident. <br />
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The key part of the background here, as <a href="http://www.ft.com/cms/s/0/8a64e3ac-8f25-11e3-be85-00144feab7de.html">Wolfgang Munchau has already pointed out</a>, is that the German court ruling effectively left OMT - which only ever had a virtual existence and was increasingly seen as an empty bluff since it was clear no one was going to accept the conditionality side - deader than that infamous dead duck. Karlsruhe's objection to the existing bond buying programme was that it went beyond the ECBs mandate since directly financing government debt is prohibited under Maastricht, and the objective of OMT was to help governments finance at an affordable price. Since break-up risk - which could have offered an alternative justification for OMT - is for the moment off the table, OMT lacks definitive legal justification and in practical terms the emperor visibly has no clothes. It is just a question of how long the markets need to wake up to the fact.<br />
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Under these circumstances, as one argument would have it, it is only a matter of time before market sentiment turns and peripheral spreads come back under pressure at which point OMT would be tried tested and severely found wanting. While I think this risk to peripheral spreads in the short run is probably overstated (since at this point market participants are so bullish they are effectively immune to flashing red light warning signals), letting Italy simply drift does involve a high level of potential risk, and certainly a higher level of risk than a prudent central banker might want to run. So that part of it I buy: Mario Draghi would be at least rooting for Renzi even if he wasn't doing anything to actively make his wish come true.<br />
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But then, enter the deflation threat. The ECB is - and not without justification (see the above chart showing the movement in 5 year index linked forwards prepared by Commerzbank's Michael Schubert) - concerned about the possibility that longer term inflation expectations could become anchored well below the 2% price stability level the maintenance of which the ECB does consider to be its mandate. Aggregated inflation across the 18 countries who constitute the monetary union has fallen and remained below 1% for an extended period of time now. In several EU countries prices have actually started falling, in others inflation has dropped to very low levels of 0.5% or below. Greek inflation is currently running at an annual rate of minus 1.4% and has been in negative territory for eleven months now (see chart above). Worse still, and again <a href="http://www.ft.com/intl/cms/s/0/918bb902-9a6b-11e3-8232-00144feab7de.html">as Wolfgang Munchau points out</a>, there is a real risk that the periphery economies drag the German inflation rate down along with them. <br />
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<i>"Germany’s federal statistics office said last week that real wages – after inflation – fell in 2013. This was unexpected because other surveys suggested they had gone up. What seems to have happened is profit-related pay and other hard-to-measure components of wages came down last year.
For the eurozone, German deflation is a nightmare. If the periphery wants to become more competitive, it needs lower inflation than Germany. But if Germany, too, is deflating, then either the competitive adjustment will not happen; or the whole of the eurozone goes into deflation; or, more likely, both." </i><br />
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<i>"Insee, the French statistics office, announced that the annual rate of core inflation – without volatile items and tax measures – dropped sharply from 0.6 per cent in December to 0.1 per cent in January. Factory prices are another forward-looking indicator. According to data from Eurostat, the EU’s statistical office, they went down in the eurozone as a whole by a whopping 0.8 per cent annually in December."</i> </blockquote>
As he says, deflation in Germany would become a true "worst case scenario" nightmare for Euro Area monetary policy. So, with the risk continuing to rise the bank will need to do something, and some version of Japan-style bond purchases seems to be the most likely thing it will do. Lowering interest rates or more initiating more LTROs simply wouldn't have a big enough impact (which doesn't mean that both of these might not happen taken as part of a broader package. This time<a href="http://www.ft.com/cms/s/0/7bbb007a-97e5-11e3-ab60-00144feab7de.html#axzz2u84Y9YYN"> the FT's David Oakley explains</a>:<br />
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<i><br /></i>
<i>"At last, after resisting for so long, the European Central Bank looks closer to implementing its own version of quantitative easing to spark growth across the eurozone.................. Investors and strategists expect about 30 per cent of the bond buying will be in German Bunds in a €400bn programme. The ECB would then likely buy about 20 per cent in French Oats, 18 per cent in Italian BTPs, 12 per cent in Spanish Bonos, with the rest being bought in the other much smaller debt markets......"</i><br />
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<i>"The German constitutional court has asked the European Court of Justice to make a ruling on outright monetary transactions, which Mr Draghi introduced as a backstop to the eurozone in the summer of 2012. Although outright monetary transactions would involve buying government bonds, it is not the same as QE as it would be introduced in the event of a run on one or more of the debt markets. The ECB could successfully argue that QE, which involves buying a range of bonds to lift inflation, was within its remit as it is designed to bring about price stability....."</i></blockquote>
So the initiation of some kind of bond purchases programme at the ECB is looking increasingly likely. If such a programme is implemented it will differ from OMT in the justification offered (to try to attain the bank's inflation objective), the fact that the bank will buy bonds from ALL countries according to their weight in Euro Area GDP, and by the fact that there will be no conditionality attached. Naturally, the fact that they will initiate such a programme doesn't necessarily mean it will work and achieve its objective. As we can see in Japan, the effectiveness of the policy is questionable, but then a central bank can hardly say, "deflation ahoy, but there's nothing we can do about it".<br />
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Whether or not it is possible to reflate economies which have entered some kind of enduring process of secular stagnation - as <a href="http://www.ft.com/intl/cms/s/2/ba0f1386-7169-11e3-8f92-00144feabdc0.html">Larry Summers obviously thinks you can</a> (or<a href="http://www.washingtonpost.com/blogs/wonkblog/wp/2014/01/14/larry-summers-on-why-the-economy-is-broken-and-how-to-fix-it/"> see here</a>) - remains an open question as far as I'm concerned. If part of the problem is demographic - as I explain <a href="http://japanjapan.blogspot.com.es/2013/05/the-b-e-of-economics.html">here</a> and <a href="http://japanjapan.blogspot.com.es/2013/05/the-real-experiment-that-is-being.html">here</a> in the context of Abenomics - then it is hard to see how you can. Possible we need to start to learn to live with deflation and find ways of managing the impact on the financial sector. As the FT's David Pilling so cogently put it recently in the Japanese context: "monetary policy can't print babies", and one day or another as our workforces accelerate their decline it may be hard to sustain positive growth. Maybe there are some realities looming out there that we are just not ready or able to accept yet.<br />
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But, going back to Renzi, the initiation of sovereign bond purchasing type QE will surely mark the beginning of a Japanese turn in ECB policy. It may start with just 400 billion, but it could then grow and grow, especially if the structural weakness in domestic demand continues to exert a downward pressure on prices even despite the money printing. So just who might benefit from this? Well, you don't have to be excessively astute to see that Italy would be prime candidate. The country currently has a gross government debt to GDP ratio of around 135%, small when compared to Japan's level of nearly 245% but still it is large and rising, especially if Italy continues to push on its fiscal deficit limits. And they will need to do this since there are no signs that the country's economy - like its Japanese equivalent - can grow any faster than it did before the global crisis without ongoing fiscal stimulus. Pushing the debt upward much beyond the current level without being forced into some kind of debt restructuring would seem to be be virtually impossible, unless........... unless the ECB start to buy the bonds. So could Matteo Renzi, who doesn't seem especially worried by the size of Italy's public debt levels be just the man for the job?<br />
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The key to the new win-win strategy would lie in the Renzi's aim getting agreement to increase the country's fiscal deficit (rather than as previously lowering the bond spread) in exchange for structural reforms. Basically any ECB Italian bond purchasing would ease pressure on Renzi in the short term. Mario would "have Renzi's back" provided he complied with the reforms. And if he didn't, well then more than likely he would simply go the way of Enrico Letta.<br />
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And to those would argue that all of this goes beyond what the German public have come to expect from Euro Area policy, I would suggest that all of what is about to happen was already evident when Mario Draghi used the famous "whatever it takes" phrase. He meant what he said. As I argued in October 2012, in a post entitled "<a href="http://www.economonitor.com/edwardhugh/2012/10/22/taking-a-man-at-his-word/">Taking a Man at his Word</a>":
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<blockquote class="tr_bq">
"<i>The heart of the issue is that Mario Draghi has vowed to do enough, and enough seems to have no limits. So what could the ECB do if we really put our imagination to work on the issue? Well like Ray [Dalio] argues, they could print money, lots of it, even to the point of doing it helicopter style. Those people who think the ECB is already printing money (which they aren’t necessarily doing when they increase their balance sheet) ain’t seen nothing yet. That’s what the “it will be enough” promise means. None of this is in the mandate yet, naturally it isn’t, but it could be, and it would be much easier to put more in the mandate than it would be to keep going to the German Parliament to ask for more money. So it could, and most probably will, happen.When you’re crossing that rope bridge and it starts to creak and sway then you just have no alternative but to continue moving towards the other side. We have all seen far too many movies about what happens to the people who try to turn back</i>." </blockquote>
Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-3949752.post-22055164920559746062012-08-10T20:41:00.001+02:002012-08-11T08:02:11.936+02:00Is The Italian Elephant About To Break Loose Again?Market nervousness about Italy has been growing in recent weeks, with the <a href="http://online.wsj.com/article/BT-CO-20120713-704619.html"> Moody's credit downgrade</a> of the country being only one of the reasons. A bailout is clearly in the offing, with the only real questions being how and when. While the situation inside his country appears to be deteriorating, Mario Monti has been doing the rounds of European capitals in an attempt to drum up support. While in Helsinki he raised an eyebrow or two when he warned that without a serious plan to bring down interest rates <a href="http://online.wsj.com/article/BT-CO-20120802-704424.html">disaffection with the euro in his country could easily grow to dangerous proportions</a>. Crying wolf, or a piece of insider information? Probably a bit of both.<br />
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Italy <a href="http://www.timesofmalta.com/articles/view/20120809/business-international/Italy-s-recession-pain-stretches-to-a-year.432184">is in a deepening recession</a> which has now lasted for over a year. Monti himself <a href="http://www.businessweek.com/news/2012-07-10/monti-says-he-wont-serve-beyond-end-of-term-next-year">has ruled out the possibility</a> that he could continue in office after next spring's general elections, while at the same time <a href="http://www.ft.com/intl/cms/s/0/24d08f80-cd04-11e1-b78b-00144feabdc0.html#axzz20hJrJVYB">Silvio Berlusconi is constantly hinting</a> that he would not be averse to accepting prime ministerial office again, should his country need him. All of which makes me ask myself just over a year after my "<a href="http://www.economonitor.com/edwardhugh/2011/05/22/is-italy-not-spain-the-real-elephant-in-the-euro-room/">Is Italy, Not Spain, the Real Elephant in the Euro Room?</a>" post, whether in fact the currently chained beast is not about to break its tethers and go for a crockery breaking rumble round the Euro living room.<br />
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What follows is a summary of a revised version of a presentation I gave in Cortona last autumn. I have put the presentation <a href="http://www.slideshare.net/Edwardhugh/whats-wrong-with-italy-a-review-of-the-countrys-economic-and-demographic-challenges">online here</a>.<br />
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<strong><span style="font-size: large;">Low Growth And High Debt, A Highly Combustible Cocktail</span></strong><br />
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Just as I highlighted <a href="http://www.economonitor.com/edwardhugh/">in the case of Portugal in my recent post</a>, Italy's problem is long term growth. This is not a passing phenomenon, but one which has been getting steadily worse over decades. Italy has lost growth at a pace of about one percent a year over the last four decades. If the pattern continues Italy GDP will drop over this decade and continue to do so for as far ahead as the eye can see.<br />
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To give us an idea of what this means, Italian GDP at the end of June was at the same level it first reached in the second quarter of 2003. If the current recession continues as forecast by the Italian government during this year, by December we will be below the GDP level of December 2000, which is another way of saying that it will be below the level first attained some 12 years earlier. If the recession is slightly deeper that the current government forecast, and continues throughout 2013 (certainly not an excluded scenario) we might even arrive at levels first seen in the late 1990s. In the meantime the country's population will have risen from 57 million to 61 million, hence GDP per capita will have fallen substantially. This is not a situation either to be taken lightly, or one which it will be easy to turn around.<br />
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There are a variety of reasons for this sharp drop in growth momentum. Some of the reasons are undoubtedly, as I will argue demographic. Others are associated with the loss of international competitiveness experienced by the Italian economy since entering the European monetary union.<br />
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Once clear indication of the extent to which the deteriorating growth outlook is associated with cometitiveness loss is to be seen in the correlation between worsening growth performance and the deteriorating current account balance.<br />
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<span style="font-size: large;">Double Dip Recession</span><br />
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Italy first fell into recession at the end of 2007 – some months before the other Euro Area countries - and didn’t come out of it again till the start of 2010 , so the economy contracted for two full years. GDP fell by 1.2% in 2008, and by 5.5% in 2009.
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After an 18 month recovery, the economy
again fell into a second “double dip”
recession around the middle of 2011, after a
surge in borrowing costs forced the
government to apply stringent austerity
cuts in an attempt to recover investor
confidence.
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In the three months up to June GDP contracted for a fourth straight quarter, falling by 0.7 percent over the previous quarter. We don't have the detailed breakdown from the statistics office yet, but it seems clear the contraction was again led by sharp falls in consumption and investment as concerns about the fiscal outlook and the euro area crisis depressed confidence and tightened credit conditions.<br />
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It is quite possible that Italy will experience a deeper recession this year and next than most forecasters predict (IMF current 2012 -1.9%), reflecting headwinds from the sovereign debt crisis compounded by Italy’s large planned fiscal adjustment. The government will likely miss its deficit targets and even in the absence of any major shocks to yields, the country’s debt to GDP ratio is surely going to increase significantly over the next few years.<br />
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Part of the problem is that Italy's fiscal spending has assumed the importance it has in the country's economy due to the loss of international competitiveness. Reducing the government contribution to GDP in this context only makes the economy fold in on itself. More urgent competitiveness raising issues are needed, ones which will bring quicker results than the ongoing programme of long term structural reforms.<br />
<br />
<span style="font-size: large;">So Just What Do We Mean By International Competitiveness?</span><br />
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The issue of international competitiveness is the one which has perhaps caused most theoretical controversy during the current Euro Area crisis, with one side arguing vehemently that some sort of devaluation is essential, while the other argues equally vehemently that it isn't. In the follwoing slides I propose a slightly new definition of international competitiveness, which is to do with having an export sector which is appropriately large given the median population age of the country concerned.<br />
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You can enlarge the slides for easier reading by clicking on them, or <a href="http://www.slideshare.net/Edwardhugh/whats-wrong-with-italy-a-review-of-the-countrys-economic-and-demographic-challenges">alternately you can view them via my slideshare version</a>.<br />
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<strong>Bottom line</strong>:<br />
• Median population age is an important economic indicator
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• Populations with high median ages tend to be export dependent
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• Export dependency gives a better, more precise measure of international
competitiveness.
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• An export dependent country is internationally competitive
when it has a large enough export sector to drive economic growth.
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<strong>Italy and The Eurozone Debt Crisis</strong>
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Total Italian debt is not excessive in comparison with some other countries in the Eurozone, but public debt is the second highest.
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Despite having normally run positive primary balances
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Italy has run general budget deficits since the 1980s
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The problem here is the weight of the debt, the burden of interest payments
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<strong>Italy Is Now Poised On A Knife Edge</strong><br />
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Italian gross government debt to GDP is currently perched just under 123% of GDP. The key factors which will influence the future trajectory are GDP growth, inflation and interest rates. With GDP falling, inflation low and interest rates rising the outlook seems quite problematic.
Hence The Problem Of Market Pressure, and concerns about interest rates. Italy is currently paying around 6% for 10 year debt issues, and <a href="http://www.bloomberg.com/news/2012-08-08/ecb-s-rescue-worsens-spain-italy-maturity-crunch-euro-credit.html">the average maturity of Italy’s debt is 6.7 years</a>, the lowest level since 2005. <br />
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The IMF currently predicts that Gross Government Debt To GDP will peak at 124% in 2013. Any significant slippage on this and debt restructuring becomes inevitable. Investors are worried with good reason. Market responses are not just simple speculation. ECB support is critical, but so are radical measures to increase the growth rate.
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<strong><span style="font-size: large;">Too Big To Rescue?</span></strong><br />
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As stated above, Italy shrank further into recession in the second quarter with a 2.5 per cent annual decline. The 0.7 per cent quarterly fall in gross domestic product, only slightly better than the first quarter’s 0.8 per cent decline, means the economy has now been contracting for over a year, and there is at least another year of the same or worse to come as spending cuts steadily bite and the Euro debt crisis rocks its way forward. The recession will weaken tax revenues and hit jobs and consumer spending, a vicious circle which makes it harder for Mario Monti, who is aiming to cut the budget deficit to 0.1 per cent of GDP in 2014, to meet his public finance goals.
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Consumer Confidence and PMI indicators suggest that the Italian government’s GDP growth estimates (of a contraction of 1.2% for 2012 and an expansion of 0.5% for 2013) are way too optimistic . The consumer confidence reading was only just up in July from June's 14 year low, and for the first time since the launch of the PMI services survey in January 1998 firms generally expected output to be lower in a year’s time than current levels.<br />
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The employers group Confindustria now forecast a contraction in GDP of 2.4% in 2012. A further fall of 2.0% is not unlikely in 2013 as the European debt crisis worsens. Compared to the other forecasters I would be more negative on the outlook for both private consumption and investment activity. In addition, with a more negative outlook for the euro area economy – destination for 43% of Italian exports — these are unlikely to put in an unexpected stellar performance in 2013.
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<strong>Unemployment Rising Sharply</strong>
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Italy's unemployment rate hit a record 10.8 percent in June, up from 10.6 percent in May. There were 2.79 million people looking for work in June, according to seasonally adjusted figures -- a rise of 37.5 percent compared to a year earlier. Youth unemployment dropped from 35.3 percent in May to 34.3 percent. These are not yet anything like Spanish numbers, but they are not to be sneezed at either.
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The number of people living in absolute poverty in Italy rose to 3.4 million in 2011, or 5.7 percent of the population, up from 5.2 percent in 2010.Those living in relative poverty for Italian standards were roughly stable at 8.2 million, or 13.6 percent. But among families with no workers and no pensioners, the relative poverty rate rose to 51 percent from 40 percent.
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<strong>Fiscal Targets Look Increasingly Out Of Reach</strong>
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The implementation of austerity measures in Italy is likely to have a substantial negative impact on the economy in the coming years. Given its lack of competitiveness, the economy lived off constant demand stimulus from the government. Without this the growth problem is likely to become worse. <br />
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There have now been five fiscal packages introduced by Italian governments since July 2011, with the objective of a cumulative fiscal consolidation of some 5.2% of annual GDP (€85.8bn) between 2011 and 2014. With the majority of the measures concentrated in 2012, there will inevitably be a large negative impact on the economy throughout this year. <br />
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Given the deep recession the country will be in over the next couple of years and poor potential growth prospects over the medium- and longer-term, Italy’s public sector balance sheet problems are likely to mount. Although the 2011 fiscal deficit of 3.9% was not particularly high in comparison with many Euro Area countries the governments projection of a close-to-balanced budget in 2014 looks hugely optimistic. A more realistic expectation would be for the deficit to be under the EU 3% level at that stage, but the danger is this could well mean gross debt to GDP will be over 130%. Above the danger mark.
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The ECB's role in the crisis both helps and doesn't help, depending on how you look at it. They have been very tardy in acting, and normally when they have done so it is been via half measures which have not got to the heart of the problem. The LTROs are a good example. Italian banks have borrowed more than 283 billion euros from the ECB via the 3
year LTROs and other liquidity operations, but this liquidity is by and large used to either purchase government bonds or buy up their own expiring debt. Buying government bonds is attractive since they pay
yields which are far above the ECB lending rates. This difference - the so called "carry" - helps bank profitability and enables them to recapitalise,
but it also means that interest rates charged to small business clients rises as they need to compete with the government for funds. Despite the fact that such practices make the banks more "joined at the hip" than ever with their sovereigns, and that their exposure to losses should the Italian sovereign eventually have to restructure rises, they remain attractive because the risk weighting and hence "capital consumption" of public sector lending under the Basle rules remains absurdly low. This is where the real private sector “crowding
out” comes.<br />
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Banks increased their holdings of the country’s bonds by about 78 billion euros in
the first six months of 2011. This forms part of the “nationalisation” of Europe’s
sovereign debt markets. Foreign investors cut their holdings of Italian government
securities by 18 percent in March from a year earlier, according to the Bank of Italy.
In the same month Italian banks boosted them by 39 percent.
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Meanwhile, as we can see in the chart above, the rate of new lending to the private sector has been falling steadily, to both households and corporates. As I say part of the problem is that as the recession deepens the credit risk perception of Italian households and companies deteriorates,as the ECB pointed out in their latest monthly report.<br />
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The report immediately produced <a href="http://www.ft.com/intl/cms/s/0/cc277fb2-e205-11e1-b3ff-00144feab49a.html#axzz22m9DwM9e">criticism from the Italian consumers’ association Codacons</a>, who complained that the ECB itself had not found a solution to this situation. “If companies are insolvent it’s because banks are strangling them, denying them credit,” Codacons said. Coldiretti, the Italian agricultural association, also estimates that 60 per cent of companies in the sector risk being starved of credit as they face interest rates that are 30 per cent higher than the average of other sectors.<br />
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This problem is more complex than it seems. It is not so much a question of credit being strangled, but of demand being strangled as austerity bites. Companies who cannot sell profitably are a high credit risk. There is demand globally, but as I am saying Italy is insufficiently competitive to take advantage of it. Bottom line, the high cost of financing Italian government bonds is pushing up longer term interest rates, and discouraging investment, and this is an issue the ECB could address, by directly buying commercial paper, for example.
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<strong>Easing In The Bailout</strong>
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The possible Italian bailout is fast becoming a tricky political issue. The technocratic government of Mario Monti <a href="http://www.bloomberg.com/news/2012-08-09/monti-s-cabinet-discussed-possible-bond-buying-request.html">would like to get an MoU agreed before handing the country back to the politicians</a>. <br />
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The request for bond buying would involve ECB secondary market purchases as well as primary market purchases by the EFSF.
It would also involve a Memorandum of Understanding which would undoubtedly contain strict conditions and an implementation supervision mechanism. The ECB would surely also have a say in those conditions if bank bond purchases were to form part of the package. Indeed, the ECB has only this week in its August bulletin <a href="http://www.ft.com/intl/cms/s/0/cc277fb2-e205-11e1-b3ff-00144feab49a.html#axzz22m9DwM9e">made clear what it thinks is required</a>. The Bank suggests countries with high unemployment
need to “abolish wage indexation, relax job protection and cut minimum wages”. The bank is not impressed with the Italian labour
reform, which is too little too late, and thinks direct wage cuts are now the only workable remedy.
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Unsurprisingly, many Italian politicians are highly reticent about being seen to hand over their country’s future to an institution with such views, which if implemented would be massively unpopular in the country, so pressure is mounting for Monti not to ask for help. That having been said, the country really has no alternative if it wants to stay in the Euro.
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<strong>Is Italy Facing A period of Growing Political Instability?</strong>
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<br />But this is just it, exactly how committed is the Italian political class to staying in the Euro? Certainly it is the one country on Europe's periphery where you can hear speeches from politicians with serious followings questioning whether there are not alternatives. Indeed Mario Monti warned on just this point <a href="http://online.wsj.com/article/BT-CO-20120802-704424.html">during his recent Helsinki</a> visit. "I can assure you that if the (bond yield) spread in Italy remains at these levels for some time then you are going to see a non euro-oriented, non fiscal-discipline-orientated government taking power in Italy," he said.
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He was, of course, referring to the ambivalence of Silvio Berlusconi on the Euro issue, and the outright hostility to the common currency displayed by the rising (5) star of Italian politics, Beppe Grillio. “After me the populists”, as Monti once said.
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A lot of these statements can be read as brinksmanship, but as BofA Merrill Lynch foreign exchange strategists<a href="http://www.bloomberg.com/news/2012-07-12/italy-exits-before-greece-in-bofa-game-theory-cutting-research.html"> David Woo and Athanasios Vamvakidis warned in a July 10 report</a>, investors “may be underpricing the possibility of voluntary exit of one or more countries” from the currency bloc. And these countries may not be the ones most widely talk about, like Greece or Spain. It was Italy, the euro area’s third-largest economy, which they found would enjoy a higher chance of achieving an orderly exit than others and would stand to benefit from improvements in competitiveness, economic growth and balance sheets.<br />
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Woo and Vamvakidis employed a variant of game theory and found that while Germany could “bribe” Italy to remain in the bloc and avoid the fallout from an exit, its ability to do so is limited. That’s because Italy has more reasons than Greece to leave so any compensation could become too expensive for Germany and Italians may be even more reluctant than the Greeks to accept the conditions for staying.
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Interestingly enough in this connection Nomura's Jens Nordvig and Nick Firoozye (whose excellent work on Euro break up dynamics unfortunately did not win them the Wolfson Prize) argue in their afterthought essay (Wolfson: What we learned about the future of Europe, Nine specific lessons from the Wolfson Economics Prize competition) that one of the things they learnt from doing the spadework was the following.
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<blockquote>
"We have constructed a data base of the relevant liabilities for each Eurozone country, and our calculations show large relevant external liabilities in Greece, Portugal, Ireland and Spain. This analysis highlights that currency depreciation following exit from the Eurozone would substantially increase the external debt burden of these countries...."<br />
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"Meanwhile, we note that estimated balance sheet effects following exit in the case of Italy and France, are substantially smaller than in other peripheral countries, mainly as a function of the prevalence of local law obligations (which can be redenominated) within external liabilities. It follows that policy makers and investors should pay close attention to the size of balance sheet effect (not only to standard competitiveness and the trade effects) when thinking about the macro impact of specific exit scenarios".</blockquote>
So, summing up briefly, while the Monti Government’s structural reforms are obviously a step in the right direction it is unlikely they will go either far enough or fast enough to significantly lift the country’s potential growth rate from its present lamentable level. Further, as the April 2013 election approaches the growing popularity of new political movements like Beppe Grillo's Five Star one could easily lead to the kind of political fragmentation already seen in Greece - Italy has hardly been a model example of the two party system - making the traditional political forces which back the Monti Government even more reluctant to accelerate the adoption of far-reaching reform.<br />
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And going beyond April, the political arithmetic of a post Monti government looks complicated, making the kind of stability needed to advance what the population may well see as "harsh" reforms unlikely. In other words, as Monti says, when I go watch out for the populists!
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This post first appeared on my Roubini Global Economonitor Blog "<a href="http://www.economonitor.com/blog/author/ehugh3/">Don't Shoot The Messenger</a>".Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-3949752.post-64879162250204933922012-01-18T11:44:00.000+01:002012-01-18T11:44:00.394+01:00Monti, The Full VersionThe version in question is an interview with the Financial Times. A <a href="http://www.ft.com/intl/cms/s/0/4385a59e-4061-11e1-8fcd-00144feab49a.html#axzz1jndaWRhQ">summary was available here</a>, but now <a href="http://www.ft.com/intl/cms/s/0/faaef4aa-4101-11e1-b521-00144feab49a.html#axzz1jndaWRhQ">they have gone live with the whole interview</a>. If you can raise it on Google or something then it is well worth a read. For one thing it will offer you a trip down memory lane. Anyone remember this? “If you’ve got a bazooka, and people know you’ve got it, you may not have to take it out.” The reference is, of course, to former U.S. Treasury Secretary Henry Paulson, who famously used the remark in 2008 congressional testimony. But as <a href="http://blogs.wsj.com/economics/2008/09/24/paulsons-bazooka-a-weapon-to-be-remembered/">Republican Senator Bob Corker pointed out in a subsequent hearing</a>: <br />
<blockquote>
“I do want to remind you that the theory behind the bazooka was that if you have a bazooka in your pocket and the markets know that you have it, you will never have to use it. I would like to point out that you not only pulled it out of your pocket and used it, huge amounts of ammunition was pulled out of the taxpayer arsenal to solve that. I think you’ve done some very deft things and I compliment you on that, but the point is that things don’t always work out the way people, in their best efforts, think they’re going to work out.”</blockquote>
Well, the idea just surfaced again, this time from the lips of Mario Monti: <br />
<blockquote>
“I’m convinced, and the IMF is also convinced, that the more pledges are made [to the rescue fund], the higher the volume of pledges made, the smaller the probability that a single euro of cash will have to be disbursed.”</blockquote>
But, <a href="http://www.bloomberg.com/news/2011-12-19/imf-bazooka-is-between-meaningless-dangerous-commentary-by-simon-johnson.html">as former IMF Chief Economist Simon Johnson once explained</a>, the latest version of the "bazooka" is unlikely to be any more successful than the previous one. <br />
<blockquote>
"Today’s proposed bazookas are about providing enough financial firepower so that troubled European governments do not necessarily have to fund themselves in panicked private markets. The reasoning is that if an official backstop is at hand, investors’ fears would abate and governments would be able to sell bonds at reasonable interest rates again. This idea is just as dubious as Paulson’s original notion. Markets are so thoroughly rattled that if a financial backstop is put in place, it would need to be used -- probably to the tune of trillions of euros of European debt purchases from sovereigns and banks in coming months. Whether or not it is used, a plausible bazooka would need to be huge."</blockquote>
Fortunately the ECB has deep pockets, and <a href="http://www.economonitor.com/edwardhugh/2012/01/16/the-massendowngrade-effect/">as I argue in this post</a>, these will probably suffice to keep short term bond yields down to acceptable levels, and help the banks fund themselves and recapitalise. What the ECB's LTRO's won't do is get new credit moving (one significant part of the initiative involves banks in the troubled periphery economies not having to write down the asset side too much too quickly, so there will be little room for "creative destruction"). As <a href="http://online.wsj.com/article/SB10001424052970204368104577136531481564726.html">fund managers Bridgewater</a> put it recently:<br />
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<blockquote>
"We believe that a) there are logical limitations to the amounts of debt that creditors will choose to lend to debtors, b) at this time numerous debtors have passed their limits, and c) the projected rates of adjustment that policy makers are using, which generally mean slightly slower rates of increase in indebtedness rather than debt reductions, cannot happen. In other words, despite attempts of policy makers to push this debt expansion further, they can’t. Significant funding gaps will remain....... understandably, central banks are now trying to fill the funding gaps with abundant liquidity. At the same time, banks must contract and consolidate as they can’t adequately recapitalize."</blockquote>
Leaving aside the tricky issue of the extent to which the latest Euro management initiative will work, Monti does have more interesting things to say. He is, for example, quite positive about Standard and Poor's: <br />
<blockquote>
“If I ever dictated anything, it must have been what S&P had to say about domestic Italian economic policy,” he chuckles, before quickly correcting himself: “I never said the three letters BBB,” a reference to Italy’s new S&P rating of triple B plus........“It’s very interesting when they go through the various factors, and concerning the political risk factor they say there is one negative: ‘The European policymaking and political institutions, with which Italy is closely integrated’,” he says. “And then they go on, saying, ‘Nevertheless, we have not changed our political risk score for Italy. We believe that the weakening policy environment at European level is to a certain degree offset by a strong domestic Italian capacity’. “I think I’m the only one in Europe not to have criticised the rating agencies,” Mr Monti boasts.”</blockquote>
As Peter Spiegel and Guy Dinmore not unreasonably conclude, the reason for this positive tone is clear: "Mr Monti’s 60 days in office have been enough to convince the agency that his government is on a path of reform that could return the country to growth and shrink its debt levels, but that <strong>European Union mismanagement of the eurozone debt crisis is dragging down struggling countries</strong>, including Italy with its €1,900bn ($2,400bn) debt mountain".<br />
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<blockquote>
"Over the course of the 90-minute interview, Mr Monti is careful not to challenge his counterparts directly. Asked whether the S&P analysis is a condemnation of Ms Merkel, who is widely viewed as the driver of the current response to the eurozone crisis, he is diplomatic: “I don’t think we can really single out one country or one person,” he says. Later on, when asked how concerned he is that strikes by taxi drivers and pharmacists could derail his reforms at home, he insists that when he wakes up in the morning, he is more concerned with “European leadership” than domestic unrest. “European leadership – not the German chancellor,” he quickly clarifies."</blockquote>Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-3949752.post-51923890620920876472011-12-26T12:52:00.001+01:002011-12-26T12:53:20.969+01:00Italy Braces Itself For The Full MontiThe Italian government, <a href="http://www.reuters.com/article/2011/12/22/italy-monti-growth-idUSR1E7ML02K20111222">Mario Monti informed the country's parliament last Thursday</a>, is now planning to concentrate its attentions on achieving economic growth. A timely decision this, since the statistics office announcement a day earlier that the country had once more fallen back into recession, while not being a surprise nonetheless does constitute a cause for concern. Not that Italy is any stranger to recession, since the country has now had five of them since entering Europe's Monetary Union at the turn of the century. In fact the Italian economy has now contracted in eight of the last 15 quarters, and GDP is back in the good old days of 2003, stuck below the level it first attained in the first three months of 2004. And of course it is now going backwards in time again. Depending on the depth of the recession now being provoked it is touch-and-go whether the economy might not at some point even revisit levels last seen in the closing years of the 1990s. And remember, this is not deflation ridden Japan, this is real, not nominal GDP we are talking about here. So far Italy hasn't been experiencing deflation, or at least not yet it hasn't.<br />
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All in all, it would be hard to say that the Euro has worked well for the Italians. Maybe it was a great opportunity that the country was unable to take advantage of, but in any event all they are going to see from here on in is the downside part of it. The inability to adjust the value of a domestic currency they don't have to compensate for all that wantonly lost competitiveness means they are going to have to do things the hard way, subjecting themselves to a collective ingestion of codliver oil the like of which the country has not seen since the harsh days of the1920s. <br />
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<strong>Sinking Below Ground</strong><br />
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The extent of the problem the country now has can be easily seen in the chart below, which shows annualised growth over a decade (as a moving average). What is absolutely shocking is that in the ten years up to 2010 Italy had an average annual growth rate of just 0.28%. Assuming growth of about 0.5% in 2011 (which may now be generous), in the decade to 2011 this will drop to 0.15%, and if we pencil in a contraction of 1% in 2012 (perfectly realistic, in fact it will probably be worse) then the number turns negative. That is to say, on average the Italian economy will have <strong>shrunk</strong> every year for a decade. <br />
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<a href="http://3.bp.blogspot.com/-y5Z_OREqBvI/TvTbvuqXpmI/AAAAAAAASys/aGsbtgxXsI0/s1600/italy+long+term+GDP.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="160" rea="true" src="http://3.bp.blogspot.com/-y5Z_OREqBvI/TvTbvuqXpmI/AAAAAAAASys/aGsbtgxXsI0/s320/italy+long+term+GDP.png" width="320" /></a></div>
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Some may say that this result is in part a by-product of the global crisis, and they would be partly right. But look at the trend over the last three decades, far from seeing some stylised version of steady state growth hovering around a constant mean, the rate of expansion in Italian output has been heading relentlessly downwards, so logically it was always bound to cross the zero line at some point. That point now seems to be about to arrive in 2012, a year which may mark a before and after in modern Italian history.<br />
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Naturally, the reason why Italian growth has fallen so far is the big point at issue here. One of the reasons is obviously a competitiveness loss resulting from higher than Eurozone average inflation sustained over a long period, but another component is possibly the impact of population ageing, which has hit Italy more than any other European country except for Germany, and it is with Germany, of course, that Italy has the largest competitiveness loss. Demographically speaking Italy is Germany minus all that export competitiveness.<br />
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Looked at from another angle, like many other countries Italy probably grew rather over trend in the years between 2004 and 2007, and then dropped back sharply in 2008. But the Italian economy fell further than most of its peers, and subsequently really failed to recover. This is the clearest demonstration of the competitiveness problem, and it won't be easy to address.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhq7jFY80KgFrcJivs7mZThLJyFcMR4gniHGgWjVhKbFEpyD5oCoS7P-4ENljv3kev7wZSIiTg_JTGvk65x9iGlopQLhojTtVvpXWoP7q1_OaaPb3HcBw5oFX5iWhwq5t2HgjAVQw/s1600/Italy+Constant+Price+GDP.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="242" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhq7jFY80KgFrcJivs7mZThLJyFcMR4gniHGgWjVhKbFEpyD5oCoS7P-4ENljv3kev7wZSIiTg_JTGvk65x9iGlopQLhojTtVvpXWoP7q1_OaaPb3HcBw5oFX5iWhwq5t2HgjAVQw/s400/Italy+Constant+Price+GDP.png" width="400" /></a></div>
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<strong>It's The Competitiveness Silly!</strong><br />
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As is well known Italy is weighted down by a massive burden of public debt (120% of GDP). Even before the recent surge in Italian bond yields servicing this debt consumed an onerous volume of government income. But this debt alone does not explain why Italy has such a poor track record. Japan, for example, has a debt burden of over 200% of GDP and still manages to eke out a better growth trajectory. The two countries are similar in that domestic demand is permanently weak (they both have elderly populations, with a median age of around 45) yet difference between the two countries is obvious, since Japan (like Germany) has a large and dynamic export sector which generates a trade and current account surplus, and this buoys investment and GDP growth. Italy, on the other hand, has a trade and current account deficit, and both of these have been worsening since the end of the last recession.<br />
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<a href="http://2.bp.blogspot.com/-0s3QiZvNXBc/TvTfmVLZs_I/AAAAAAAASy4/d8fpl2oie00/s1600/Italy+Trade+Deficit.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="199" rea="true" src="http://2.bp.blogspot.com/-0s3QiZvNXBc/TvTfmVLZs_I/AAAAAAAASy4/d8fpl2oie00/s320/Italy+Trade+Deficit.png" width="320" /></a></div>
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<a href="http://2.bp.blogspot.com/-LB5BrrkQPdI/TvTgALQY5pI/AAAAAAAASzE/qLUfW-6wU6M/s1600/Italy+Current+account+deficit.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="183" rea="true" src="http://2.bp.blogspot.com/-LB5BrrkQPdI/TvTgALQY5pI/AAAAAAAASzE/qLUfW-6wU6M/s320/Italy+Current+account+deficit.png" width="320" /></a></div>
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Naturally a negative trade balance weakens the GDP reading, given the impact of the net trade effect, but curiously the recent GDP slowdown has been associated with a drop in government spending (which is what previously had been sustaining Italian GDP in positive territory), a fall in domestic consumption, and a consequent fall in imports (which is why the trade balance has been improving somewhat of late). Indeed, the reduction in imports meant that the net trade effect was one of the few positive points in the latest GDP reading - even while the economy contracted by 0.2% net trade added 0.8 percentage points to what would otherwise have been a devastatingly bad number. So there is no need to call in inspector Clusot to find out what happened, it was clearly the sharp cut in government consumption that finally killed off the fragile Italian recovery, although naturally, given that government debt was - and has been for some years - on an unsustainable path, the spending tap had to be shut off at some point. What Italy now needs - like so many of the countries on the EU periphery - is a sharp improvement in international competitiveness and a significant surge in investment into the export sector. The two of these naturally go together, since few will invest in activities which are unlikely to be competitive and profitable.<br />
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<a href="http://1.bp.blogspot.com/-Jnqf8HtSnDI/TvTiCgJc62I/AAAAAAAASzQ/EOui-xJnHY8/s1600/Italy+Constant+Price+Exports.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="192" rea="true" src="http://1.bp.blogspot.com/-Jnqf8HtSnDI/TvTiCgJc62I/AAAAAAAASzQ/EOui-xJnHY8/s320/Italy+Constant+Price+Exports.png" width="320" /></a></div>
Italy does have a stronger export sector than some of its Southern European counterparts, and exports did surge as the global economy started to recover (see chart above), but they never managed to reach their pre crisis level, and now, at least according to the latest PMI surveys, they are weakening once more as the European and global economy slows.<br />
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<a href="http://4.bp.blogspot.com/-5obywuPCKmc/TvcyRakv1GI/AAAAAAAASzc/OsxF9ZefGtc/s1600/italy+manufacturing.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="170" rea="true" src="http://4.bp.blogspot.com/-5obywuPCKmc/TvcyRakv1GI/AAAAAAAASzc/OsxF9ZefGtc/s320/italy+manufacturing.png" width="320" /></a></div>
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Italy was far from having a consumer boom during the good years of the first decade of this century. In fact household consumption grew by less than 5% between 2000 and 2008, and in any event the pace was much slower than in the 1990s (see the shift in steepness of the slope in the chart below).<br />
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Retail sales have been falling since 2007.<br />
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<a href="http://4.bp.blogspot.com/-ikHE2WqTER4/Tvc-yoqsD9I/AAAAAAAAS0M/ZtKw4Bf4cpk/s1600/Italy+Retail+Index.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="170" rea="true" src="http://4.bp.blogspot.com/-ikHE2WqTER4/Tvc-yoqsD9I/AAAAAAAAS0M/ZtKw4Bf4cpk/s320/Italy+Retail+Index.png" width="320" /></a></div>
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And construction spending has been one steady slide down.<br />
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<a href="http://1.bp.blogspot.com/-WWu--OTkeJ4/Tvc_5q0IjwI/AAAAAAAAS0Y/971PmsboTn4/s1600/Italy+Construction+Spending.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="192" rea="true" src="http://1.bp.blogspot.com/-WWu--OTkeJ4/Tvc_5q0IjwI/AAAAAAAAS0Y/971PmsboTn4/s320/Italy+Construction+Spending.png" width="320" /></a></div>
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And yet, despite all the pressure on Italian banks there is (as of October) no sign yet of a sharp credit crunch affecting either firms or households, since private sector credit is still growing at an annual rate of around 4%, a stark difference from the picture in Greece, Spain, Ireland and Portugal where private sector credit is steadily contracting.<br />
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<a href="http://4.bp.blogspot.com/-OER9BvXKrtU/TvdAemgFmQI/AAAAAAAAS0k/yHNXdAVPe1o/s1600/Bank+Lending.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="188" rea="true" src="http://4.bp.blogspot.com/-OER9BvXKrtU/TvdAemgFmQI/AAAAAAAAS0k/yHNXdAVPe1o/s320/Bank+Lending.png" width="320" /></a></div>
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<strong>No Boom, No Bust</strong><br />
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So to be clear, Italy did not have any sort of housing or credit driven boom during the first decade of the century, Italian households and companies are not massively in debt when compared with their Euro Area peers, and credit is not in especially short supply. Ageing population dynamics lead domestic consumption to be weak in Italy (following a pattern which is strikingly similar to that seen in Japan and Germany), yet Italy's export sector has been allowed to drift as competitiveness has been lost. Really the most telling chart I have is this one, which shows how as the current account surplus has widened (ie as competitiveness has been lost) long term growth has steadily declined. <br />
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<a href="http://4.bp.blogspot.com/-O3pH2pm7t2A/TvdED70OrHI/AAAAAAAAS0w/5cLfhmM8Usk/s1600/Italy+GDP+%2526+CA+Compared.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="183" rea="true" src="http://4.bp.blogspot.com/-O3pH2pm7t2A/TvdED70OrHI/AAAAAAAAS0w/5cLfhmM8Usk/s320/Italy+GDP+%2526+CA+Compared.png" width="320" /></a></div>
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With neither exports nor private consumption able to pull the economy the state has been under constant pressure to offer support via deficit spending, leading to the accumulation of an unsustainable quantity of government debt. This deficit spending is about to come to an end (permanently according to the latest EU agreement), and under these circumstances the economy is likely to remain in or near contraction for as long as it takes to recover competitiveness. The question is, how long is that going to be, and what will happen to the debt dynamics in the meantime.<br />
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To take the second question first, one of the reasons that many are confident Italy will make it on through with the debt challenge is the country's recent record in controlling the deficit. According to OECD data, while Italy ran a cyclically adjusted primary <strong>deficit</strong> every year between 1970 and 1991, it ran a cyclically adjusted primary <strong>surplus</strong> every year since 1992. That is to say, before allowing for interest payments Italy has not been running a deficit for many years now, and it is simply the burden of servicing the accumulated debt which is causing the country to spend more than it receives in revenue. As many of those who are in the "optimistic" camp on the question of the country's ultimate solvency eagerly point out, Italy’s cyclically adjusted primary balance as a proportion of GDP has remained in a better shape than those of the largest developed countries as well as those of European peripheral and core countries since the onset of the crisis. It is only the legacy of the past which acts like a dead weight pulling the country down, but what a legacy this is, and especially as yields on Italian debt have steadily risen.<br />
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<strong>Poised On A Knife-edge</strong><br />
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But given everything it is clear that Italian debt, and with it the future of the Euro, now sits poised on a knife edge, as is illustrated in the chart below (which comes from Barclay's Capital). If you take a neutral scenario where Italy has a balanced budget and a sum total of zero nominal GDP growth (ie growth+inflation = 0) debt stays put at 120% of GDP out to infinity. <br />
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<a href="http://1.bp.blogspot.com/-1vdaYODE47k/TvduKKeYe_I/AAAAAAAAS1g/UEPGDzJ2nbk/s1600/Italy+Knife+Edge.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="164" rea="true" src="http://1.bp.blogspot.com/-1vdaYODE47k/TvduKKeYe_I/AAAAAAAAS1g/UEPGDzJ2nbk/s320/Italy+Knife+Edge.png" width="320" /></a></div>
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But then imagine the average finance cost of Italian debt rises, and stays high. In this case the only way to compensate is by running a larger primary surplus (ie more spending cuts, or revenue increases to compensate for the extra interest cost). The net effect of this would either be to generate deflation or a more sustained economic contraction, in which case debt to GDP would start to rise indefinitely. Think of it like this, either prices fall by one percent and GDP (via exports) rises by 0.5% (for example), in which case nominal GDP falls 0.5% a year (the Japan type case), or prices rise by 0.5%, exports lose more competitiveness, and so growth falls by 1%. I mean, this example is only illustrative, but it is meant to give some sort of feel for what "knife edge dynamics" really mean.<br />
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In fact, before the recent surge in the spread, average interest costs on Italian debt had been falling in recent years, but now they are evidently rising again. It is very important here to remember that yields in bond auctions only affect new emissions of debt (and changes in the secondary market only really affect banks, and sovereigns through possible needs to recapitalise banks). So it is a question of years before the higher levels "lock in" - the average maturity on Italian debt, for example, is around 7.2 years, and indeed since governments finance at fixed and not floating rates (not at a certain % above 3 month Euribor, for example), debt costs are at much at risk from increases in ECB base rates as they are from the actual spread with German bonds. Any substantial increase in interest costs naturally makes selling debt more expensive. Fortunately for peripheral sovereigns, the likelihood of ECB rate rises in the foreseeable future is near to null.<br />
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<a href="http://4.bp.blogspot.com/-XVMblI7oIaA/Tvd2EBr1HwI/AAAAAAAAS1s/zJ8Tp8IlZeo/s1600/Italy+debt+two.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="275" rea="true" src="http://4.bp.blogspot.com/-XVMblI7oIaA/Tvd2EBr1HwI/AAAAAAAAS1s/zJ8Tp8IlZeo/s320/Italy+debt+two.png" width="320" /></a></div>
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<strong>No Way Back Home</strong><br />
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But again, let's do another thought experiment. Imagine I am right, and Italian debt is on a knife edge path, and suppose the average interest rate on the whole debt creeps up by 1 percentage point. With debt at 120% of GDP, then the primary surplus to cover the added interest costs and maintain a balanced budget would be 1.2% of GDP. But suppose, for the sake of argument, that increasing the primary surplus by 1.2% pushes Italian debt to gdp up to 125% (via a combination of either deflation or economic contraction), then the next year the primary surplus would need to be up by an additional 0.05%, helping force debt to GDP up even further and so on and so forth. This is why people call this the debt snowball. The point is, whichever way you turn, you seem to find the exit door locked.<br />
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Coming back to the details of the present situation, the Italian government has committed itself to a consolidation program worth €74bn over the next two years amounting to roughly 3.7% of GDP. This is designed to bring the budget into balance (or the deficit to zero) by the end of 2013. On quite conservative assumptions, just to tread water, and maintain the debt level where it will be in 2013 (which will be more than 120% of GDP due to the recession), Italy will need a primary surplus of 2.3% of GDP. <br />
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But then we need to think about the recently undertaken commitment to reduce the debt (the last EU summit). The exact numbers have yet to be agreed for the new pact, but it looks like a cyclical maximum of 0.5%, and (even more importantly) a commitment to reduce outstanding debt over 60% of GDP by 5% a year. This, in Italy's case will mean the country is going to need (from 2014 onwards) a primary balance of something like 5.5% of GDP (depending on the evolution of interest costs) over the rest of this decade. Which means the Italian economy is going to face an even more restrictive fiscal environment.<br />
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<a href="http://3.bp.blogspot.com/-Llggj37jjiw/TveIws8UZMI/AAAAAAAAS14/tZCbPqycbOM/s1600/Italy+Debt+One.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="302" rea="true" src="http://3.bp.blogspot.com/-Llggj37jjiw/TveIws8UZMI/AAAAAAAAS14/tZCbPqycbOM/s320/Italy+Debt+One.png" width="320" /></a></div>
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Now, those who argue the Italian crisis will have a happy outcome point to history, and argue that Italy was able to achieve a primary surplus of around 5% on average during the years 1995-1998, so why shouldn't the country be able to do this again? The main counter argument would be that that was then, and this is now. That is to say, these were the years of Italian "coupling" with monetary union, sizable privatisation programmes, falling (not rising) interest rates, and basically Italian trend growth had not fallen as far as it has now.<br />
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Moreover, the external environment in Europe will not exactly be conducive to boosting exports. Even core Euro Area countries are commited to undertaking additional fiscal consolidation beyond what is currently envisaged in order to comply with the new debt rule. Taking 2014 as the starting point, debt to GDP for the Euro Area as whole might be something like 90%. Hence the 1/20th rule would imply that on aggregate the Euro Area will need to reduce its debt ratio by around 1.5 percentage points per year. If this agreement is complied with the adjustment will almost certainly imply a net fiscal drag on growth in the years following 2013. Of course, if it is not complied with then it will almost certainly be "bye bye Euro" (assuming the common currency still exists that far up the road).<br />
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<strong>It's All About Structural Reforms, Or Is It?</strong><br />
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So basically, what the whole argument about whether or not Italy can make a final burst and reach the finishing line is all about structural reforms, and whether the country can get enough growth (quickly enough) to turn the "knife edge trap" around. Personally I am extremely doubtful that it can, which is why I placed so much emphasis on the growth performance in the first section. The turnaround needed here is massive. It is a 30 year decline we are talking about, and I doubt short of outright default and substantial devaluation we have historical examples of anyone doing this. The adjustment made in Germany between 1999 and 2005 was much smaller in comparison. <br />
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<a href="http://2.bp.blogspot.com/-i02kML0gLsc/TveNt6SkWaI/AAAAAAAAS2E/WM5KIr8JeUw/s1600/Italy+Employed+Population.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="181" rea="true" src="http://2.bp.blogspot.com/-i02kML0gLsc/TveNt6SkWaI/AAAAAAAAS2E/WM5KIr8JeUw/s320/Italy+Employed+Population.png" width="320" /></a></div>
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One of the proposals is to introduce labour market reforms to increase participation rates, but in fact the Italian labour force grew substantially between 2004 and 2008 (due to large scale immigration), with employment being up by over a million (or around 5%, see chart above), yet the increase in output was ridiculously small. On the other hand we know the Italian working age population is contracting (and the average age rising), while the elderly dependent population is increasing rapidly. Conventional economic models tend to be silent on this issue, but common sense should tell us that this is going to take its toll on growth - a factor the "structural reform answers all our problems people" don't seem to have given enough thought to.<br />
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The Monti government needed just five weeks in office to push through an additional 30 billion-euro emergency budget package, but how long will he need to get GDP growth back up above 1% annually? And how much time does he have? Investors initially cut him some slack, but judging by the reaction to the final approval of the package by the Senate - the yield on Italy’s 10- year benchmark bond was pushed up by 12 basis points to 6.91%, dangerously close to the key 7% level (although still somewhat below the Euro era record hit on November 9, just before Monti took charge). 7% is widely considered to be critical if sustained for any great length of time, partly due to the cost of debt servicing but also because of the level of dependence of Italian banks on the ECB that it would produce.<br />
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<strong>Till The Dowgrades Fall</strong><br />
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So the "Full Monti" effect now seems to have been priced in, while investors nervously wait to see what the real plan for Spain and Italy actually is. <br />
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The first quarter of 2012 looks to be critical for Italian debt, with about one third of the total Euro Area debt maturing being Italian. Indeed the battle starts this week with the Treasury having to sell an assortment of T-bills and 2 year and 10 year bonds. In addition the Italian government is now increasingly guaranteeing bonds issued by Italian banks to be used as collateral at the ECB - with about 40 billion euros being issued last week according to some estimates. So effectively Italy is now more or less guaranteeing the banking system with the likely outcome that ratings agencies will be even harder on the sovereign rating. <br />
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Not that the outlook was exactly bright on that front anyway. Understandably, Italy was among the 15 Euro Area countries Standard & Poor’s placed on review for a possible downgrade on December 5. This follows an earlier downgrade to a single A by the agency in September. In addition, Spain and Italy were both warned by Fitch (which cut Italy's rating to A+ on October 8) on December 15 to brace for a further debt downgrade after concluding that a "comprehensive solution to the eurozone crisis is both technically and politically beyond reach". And to complete the set, Moody's, which cut the country to A2 on October 4, maintained a negative outlook, signifying that a further dowgrade in the coming months was highly probable The bottom line is that Italy is both too big to fail and too big to be bailed out, which is why it is still hanging dangerously in limbo-land. Since, as I argue in this article, some sort of restructuring or other is well nigh inevitable in the Italian case, the sooner Europe's leaders work up a credible plan on how to achieve this, the better. Otherwise it will not only be Italy's citizens who are subjected to the Full Monti, Europe's leaders may also find themselves with their credibility stripped naked. <br />
<br />
This post first appeared on my Roubini Global Economonitor Blog "<a href="http://www.economonitor.com/blog/author/ehugh3/">Don't Shoot The Messenger</a>".Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-3949752.post-19833181930787904132011-08-17T21:00:00.000+02:002011-08-17T21:32:17.733+02:00The Policymaker's Fear Of The Italian Penalty Shot<blockquote>“While the impact of service-sector liberalization and privatizations may be positive on medium-term growth, the budget cuts are likely to have quite negative effects on the short-term GDP dynamic. We expect Italian GDP growth to slow to close to zero in 2012 and 2013.” Giada Giani, Citigroup</blockquote>
<br />According to one anonymous German official speaking off the record <a href="http://www.spiegel.de/international/spiegel/0,1518,780258-3,00.html">to reporters from Der Spiegel</a>, "a country like Italy can't be saved". We will have to trust that he was referring to the country's size when he made the statement, and not its existential core. If he was, he may well be right, at least under the Euro Area's current institutional arrangements. Let's take a quick look at why.
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<br /><strong>The ECB Backstop Works For Now</strong>
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<br />The Italian debt markets are a lot calmer this week than they were the week before last. Evidently there is a simple explanation for the phenomenon, and that is that the level of Italian bond yields is now more or less completely guaranteed by the European Central Bank (the ECB). Systematically and meticulously, the Italian ten year bond yield is being maintained at or around the 5% level by a team of dedicated bond traders in national central banks dotted around the Euro Area.
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<br />The process whereby this result is achieved is not that dissimilar to other more common central bank interventions, for eaxmple to target a certain exchange rate, or a given overnight interest rate. Basically, when the yield rises above a given threshold the ECB's representatives simply step in and buy bonds. This happened last week to the tune of some 22 billion euros, with bonds being acquired from a set of 5 EU peripheral countries, although we don't know how the purchases were broken down at national levels. One thing was for sure, there were a hell of a lot of Italian bonds tucked in there somewhere.
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<br />The problem for the bank now is that once you initiate a programme like this, there is no easy way to stop. Despite many voices who argue the contrary, Italy's problem is not simply a short term liquidity one (funding a deficit), it is a long term solvency one (servicing an enormous pile of debt and growing at the same time). While the country has long maintained a primary surplus, the weight of the debt has drifted steadily onwards and upwards. Italy is caught in a conundrum. With low growth you need inflation to be able to make the books balance, but this excess inflation makes the country's competitiveness problem steadily worse. If you implement the reforms needed to make the economy more competitive then you don't get the inflation, and if you take away the deficit in the meantime then you simply don't get growth. This is a zero sum game in which all the numbers don't add up.
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<br /><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiXdx6J5xpeQGUvdgDU1Fjk5CS6S_8kGTk9nL1gsljvjlNWaCvXKWd7GZdHOLh_Y9lNe0SjmflE8XdEFueczQRJlxP8uRMWSsBF5yxHYEx09aI4-Vn9ZZPNl-uKJg4ETGR0WnJp5w/s1600/Italy+%2526+EA17+CPI+compared.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiXdx6J5xpeQGUvdgDU1Fjk5CS6S_8kGTk9nL1gsljvjlNWaCvXKWd7GZdHOLh_Y9lNe0SjmflE8XdEFueczQRJlxP8uRMWSsBF5yxHYEx09aI4-Vn9ZZPNl-uKJg4ETGR0WnJp5w/s400/Italy+%2526+EA17+CPI+compared.png" /></a>
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<br />At the push of an ECB "buy" button, Spanish and Italian sovereign bonds have effectively been taken out of the markets, and it is now hard to see how (without some sort of restructuring or other) they can now ever get back in again.
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<br />In ceding to pressure from Europe's leaders to take this decision, the central bank has now gotten itself locked onto the horns of a huge dilemma, and they are going to have great difficulty finding a way to extract themselves from it. Monsieur Trichet has lodged his finger well and truly inside the wall of the dike, and should he even momentarily take it out again, the whole structured could easily rupture, with many of the things we now know and love getting carried away in the ensuing flood. </p>
<br /><p>Of course, the mere threat that he might one day do this does serve to concentrate all the various minds involved, but what is involved is a form of brinksmanship which could in itself one day become a problem.
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<br />A glimmer of what the bank is now getting itself involved in can be seen in last week's ECB balance sheet reading, since it grew to the year-to-date high of 2.073 trillion euros last, largely as a result of increased lending to eurozone financial institutions and additional sovereign bond purchases.
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<br />The balance sheet was up by 68.736 billion euros over the previous week, and 119.94 billion euros over the same period one year ago. In part the balance sheet surge was due to an increase in net lending to credit institutions (which increased by 98.3 billion euros to 393.3 billion euros). And in part it was up due to the 22 billion euros spent in bond purchases. Curiously the weekly fixed term deposit levels remained unchanged at 74 billion euros (the quantity spent in periphery bond purchases to date), which sort of settles the issue of whether the bank were going to "sterilise" the new purchases, or create additional money to pay for them. For the time being at least they seem to be doing the latter, since going by the size of the banks current account holdings (which jumped to 286.783 billion from 159.814 billion euros a week before) they seem to have offset the purchases through money creation.
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<br />Basically central bank bond purchase intervention is deemed to be "neutral" in monetary policy terms if an equivalent quantity is drawn back from the banking system by attracting new term deposits at the central bank. That the bank may be carrying out a "money printing" exercise (and especially one to monetarise the debt of certain countries in particular) is raising fears of impending inflation. My feeling is that, in the context of heavily over a leveraged private sector and congenitally weak domestic demand, this is not a real concern at present for the Euro Area. I think the ECB's own inflation alert was always overdone, since most of the inflation we have seen of late has either been imported (via rising energy and commodity prices) or adminstratively generated via consumption tax increases. There has been very little in the way of second round effects.
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<br />The real worry then should not be inflation, but whether or not the Italian government will ever be in a position to honour the bonds in full, and on time. At the present time this is only a theoretical question, since additional bond purchases can always enable the Italian state to meet its obligations, with the ECB facilitating debt rollovers by using the commercial banks as proxies in the primary markets. But just how deep in do you want to get? At the present time the bank owns something like 20% of outstanding Portuguese, Irish and Greek debt. 20% of Italian debt would be something like 380 billion euros, a volume of bonds which would already be difficult to pass over to the EFSF (or its heir the European Monetary Fund). But in this case the force of tradition is not strong, and there is no real reason why the bank need stop at 20%. The sky could be the limit, and the ECB could be transformed into the new Bank of Japan, effectively light years away from the earlier visions of the Bundesbank founding pioneers. And, of course, we would all be into one of those processes which can go on for just as long as they can.
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<br /><strong>The Balanced Budget Ammendment</strong>
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<br />At the heart of the recent ECB decision lay something known as the <a href="http://en.wikipedia.org/wiki/Balanced_Budget_Amendment">balanced budget ammendment</a>. First introduced in Germany in 2007, this is a constitutional change which (in the German case) makes a deficit of over 0.35% of GDP illegal as of 2016. One of the conditions <a href="http://www.ft.com/intl/cms/s/0/55a75904-c526-11e0-ba51-00144feabdc0.html#axzz1VCX1a6U9">the ECB imposed on Italy was that they also change their constitution</a>, but in this case outlawing deficits as of 2013. Effectively, and at a single stroke, this brings to an end a whole era of Keynesian counter-cyclical fiscal policy and economic management. So the implications are large, and hard to separate from the rapidly ageing population phenomenon.
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<br />While it was the size of the latest package of cuts which hit the headlines (<a href="http://www.ft.com/intl/cms/s/0/55a75904-c526-11e0-ba51-00144feabdc0.html#axzz1VCX1a6U9">Rome orders €45bn in cuts and taxes</a>), the key issue was really the balanced budget ammendment, since this has one clear implication: as of 2013 there will be no new bonds. So at least now the outer limit of ECB exposure is a known fact.
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<br /><strong>Chronicle Of A Crisis Long Foreseen
<br /></strong>
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<br />While the Italian crisis may have crept up on markets all at once and unexpectedly, issues about the sustainability of Italian debt are not new. <a href="http://ftalphaville.ft.com/blog/2011/06/22/601176/when-italy-is-already-priced-to-wreck-the-eurozone/">As FT Alphaville's James Coterill noted</a> when the latest wave in the Italian crisis broke out: "In the original ‘why the eurozone will break up’ papers of the 1990s and early 2000s, it was never ever high Greek deficits, or Irish (or Spanish) bank losses going on to public balance sheets that were forecast to destroy the single currency. It was always Italy. High-debt, low-growth, Italy".
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<br />Exacty, Italy was always the greatest worry on everyone's minds, including the ECB's. Indeed, the now long forgotten minimum rating requirements for collateral posting at the bank <a href="http://eurowatch.blogspot.com/2005/11/promises-promises-but-more-than.html">were first muted by them with precisely Italy in mind</a>. I myself wrote one blog post after another (see links below) warning of the danger which was looming, buried in Italy's toxic combination of low growth, rapidly ageing population and high accumulated debt. It was simply a crisis waiting to happen, and now it has. As <a href="http://www.nytimes.com/2010/06/09/business/global/09blogger.html">the New York Times' Landon Thomas noted in the Blog Prophet of Eurozone Doom</a> article he wrote about my work, "Mr. Hugh’s demographic thesis is not airtight: in fact, it was Italy, not Greece, that attracted his early attacks. But Italy, perhaps because its overall debt level was already so high and its population was older, pursued a policy of greater fiscal rectitude than its neighbors and avoided a real estate bubble".
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<br />Not airtight, but nearly-so it seems, since behind the short term obsession with fiscal rectitude there lie the longer term preoccupations about solvency and debt. And here Italy (and eventually Japan) jump right back into the cockpit. As Landon mentions, Italy didn't have a housing boom worthy of mention, so private debt didn't surge during the first decade of the century, and during the crisis Finance Minister Tremonti pursued a policy of flying under the radar by keeping deficit spending low. But now short term deficit issues are waning, and longer term solvency questions are surfacing in the wake of the renewed Greek crisis. Thus, while historians of the future may well struggle to understand just how it was that a simple fiscal deficit bailout programme was so badly handled that Greek sovereign debt shot up from around 110% of GDP entering the crisis to around 170% by the end of the "rescue" period (and this without even having enjoyed a real housing bubble, ie with a private sector that was not massively in debt), the Italian case will raise few eyebrows, since every thinking economist had seen it coming for so long (Japan too, see my Italy blog <a href="http://eurowatch.blogspot.com/2005/11/promises-promises-but-more-than.html">here</a>, <a href="http://italyeconomicinfo.blogspot.com/2007/07/credit-rating-agencies-pensions-ageing.html">here</a>, <a href="http://italyeconomicinfo.blogspot.com/2006/09/wolfgang-munchau-and-eurozone.html">here</a> and <a href="http://italyeconomicinfo.blogspot.com/2007/06/macroeconomic-adjustment-in-euro-area.html">here</a>).
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<br /><b>Low Growth and Ageing Workforce Are A Troubling Backdrop</b>
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<br />Italy's problem is not its fiscal deficit, in fact in every year since 1991 Italy has run a cyclically adjusted primary balance (that is before interest payments are taken into account), it is the weight of the accumulated debt burden and low growth. The country's trend growth rate has been falling for decades, and during the first decade of the present century it only managed to grow at an average rate of about 0.6% per annum.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhb5zOkvx6e8PzP8rIez3E5ddMMYi7azdR_2nedJPLEK7EGhjPXEAF8XnZj4unHekxRiHlJCG2Ls8M6EFM0l-p9mzXM_0H7Z_wLkjXS9zL-munJYb6VtKpBBRwQumAIyFV62akfSg/s1600/italy+long+term+GDP.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhb5zOkvx6e8PzP8rIez3E5ddMMYi7azdR_2nedJPLEK7EGhjPXEAF8XnZj4unHekxRiHlJCG2Ls8M6EFM0l-p9mzXM_0H7Z_wLkjXS9zL-munJYb6VtKpBBRwQumAIyFV62akfSg/s400/italy+long+term+GDP.png" /></a>
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<br />Even though the quarterly GDP growth rate accelerated slightly in Q2, and reached a quarterly rate of 0.3% (up from the 0.1% expansion achieved in the first three months of this year), the slowdown in core Europe, and the readings on the most recent PMIs leave little doubt that the respite will be short lived. At this point even the current IMF forecast for modest 1% GDP growth in 2011 is looking very optimistic. And if the country now slips back into recession (certainly not excluded) then the under-performance would be much greater.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhacjYeh23IBYMjP8_DeQabe_Dl2qYMR4T-UvQsmYhfNEgc394kKio-RmU49o1G63Baw4vEA48_HbYLtwfS7IR6c7jhSo5Nv0ep_U7kkGmgMKpFSp63vnsST4nFLGyKXpRaxa7N-w/s1600/Core+versus+periphery+output+index.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhacjYeh23IBYMjP8_DeQabe_Dl2qYMR4T-UvQsmYhfNEgc394kKio-RmU49o1G63Baw4vEA48_HbYLtwfS7IR6c7jhSo5Nv0ep_U7kkGmgMKpFSp63vnsST4nFLGyKXpRaxa7N-w/s400/Core+versus+periphery+output+index.png" /></a>
<br />The worrying thing is how Italy has been able to get so little growth out of so much. This is especially the case when you take into account the fact that during the last decade the country's labour force grew steadily, following the arrival of several million new migrant workers. Between 2002 and 2010 the number of non-Italian citizens officially residing in Italy was up by 3 million (or 200%).
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhEzTZJFu9kahjCHnyyJ8_lq-HbzRn6DlbcK0ZpGJWfEpFDsRUe6V32aq8Q93kBPLhsgasDAjZvvF9wIsAFuw7MOAw5UCp6h3GNKCDq4ULaeGAKtSoYVEsHdzlBIs32aU0UkIxHIg/s1600/Italy+foreign+population.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhEzTZJFu9kahjCHnyyJ8_lq-HbzRn6DlbcK0ZpGJWfEpFDsRUe6V32aq8Q93kBPLhsgasDAjZvvF9wIsAFuw7MOAw5UCp6h3GNKCDq4ULaeGAKtSoYVEsHdzlBIs32aU0UkIxHIg/s400/Italy+foreign+population.png" /></a>
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<br />During this time the labour force grew by about a million:
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjOUduJVfMwgo5mXboz_1_3d6ClNH1DBSNvDyFdmogBMfEuf0FJ11-qpW7AOAkQnbzA8WmmczwKWupUqAAZvxzglAEetq4k0scWKwcqX634yDebBSlrIOEzg-TzpxAved2HIeP2Ag/s1600/Italy+Labour+Force.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjOUduJVfMwgo5mXboz_1_3d6ClNH1DBSNvDyFdmogBMfEuf0FJ11-qpW7AOAkQnbzA8WmmczwKWupUqAAZvxzglAEetq4k0scWKwcqX634yDebBSlrIOEzg-TzpxAved2HIeP2Ag/s400/Italy+Labour+Force.png" /></a>
<br />while employment was up by around 1.5 million.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEilxO4mYco9TCpwp7fTuE8Qh8H253vShdNPe8KLiQuc1vKC-5qL15zJHN1pB2oSGthy9S734iotJT0tK3MShnE6OfTP0hay0HiUPCwvtt_ftWdbKfYXN_SF-2tnsv7EI2Zo_to8xQ/s1600/Italy+Employed+Population.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEilxO4mYco9TCpwp7fTuE8Qh8H253vShdNPe8KLiQuc1vKC-5qL15zJHN1pB2oSGthy9S734iotJT0tK3MShnE6OfTP0hay0HiUPCwvtt_ftWdbKfYXN_SF-2tnsv7EI2Zo_to8xQ/s400/Italy+Employed+Population.png" /></a>
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<br />Yet GDP barely rose. In fact, since Italy left recession the number of those employed has hardly risen, while the percentage of those who are formally unemployed has remained near its crisis highpoint, which has been good for productivity, but not for consumer consumption. The ideal combination would be to see both output and employment growing in tandem, but with output growing faster than employment. At the present time employment is hardly growing, and the rate of increase in output is slowing notably. That is to say we do not have "lift off".
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj7JPAOKMEZsPLWK0zGcNTaJw52xG_1aWTU8TRt2VRJeb8Kkf6oL12rQk_7Iw_5qkhdsSQAyVPpokqqkEzy3aRhyphenhyphenczjW9GyQeYuPGr7ZVrN_TkzGaPswK15xLvPBSBLdBEDIFaHjw/s1600/Italy+Unemployment+Rate.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj7JPAOKMEZsPLWK0zGcNTaJw52xG_1aWTU8TRt2VRJeb8Kkf6oL12rQk_7Iw_5qkhdsSQAyVPpokqqkEzy3aRhyphenhyphenczjW9GyQeYuPGr7ZVrN_TkzGaPswK15xLvPBSBLdBEDIFaHjw/s400/Italy+Unemployment+Rate.png" /></a>
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<br /><strong>Slamming The Debt Brake Pedal Down To The Floor Won't Work</strong>
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<br />Despite the fact that the real leverage M Trichet now has over the Italian government is being exercised in order to obtain the constitutional change required for the balanced budget rule to be put in place, the severity of the fiscal tightening that Italy will now experience should not be taken lightly. In the first place something like 45 billion euros in new cuts will be implemented in 2012 and 2013, and this will be on top of the previously agreed package of 47.8 billion euros in cuts between now and 2014 agreed in the July budget.
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<br />In addition Italy will now aim for a general budget deficit no greater than 0.2% of GDP in 2013 (Germany will not achieve this result till 2016), and will maintain that ceiling into the indefinite future. Basically, this will mean the post 2012 Italian budgets will need to aim for an average primary surplus of just under 5% of GDP during the subsequent years, as the weight of the debt is gradually ground down, and the burden of interest costs reduced. This is a difficult, but not impossible task.Between 1995 and 1998, when Italy’s undertook its maximum effort to enter the monetary union, the average primary surplus was 5.0% of GDP. However, during the second half of the 1990s Italy was benefiting from both decreasing interest rates and also from the depreciation of the Lira. In addition the Italian government also implemented a significant privatization programme which helped to reduce the debt/GDP ratio. Most of these positive tailwinds will not be available this time round.
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<br />As Deutsche Bank analyst Marco Stringer puts it: "While there are no doubts that Italy needs to maintain a very prudent fiscal policy, there is a risk that an excessive fiscal consolidation could be counterproductive were it to have a significant negative effect on growth".
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<br />There is a very real possibility that Italy's fiscal consolidation, like Greece's, is so sharp as to be counter-productive, with the low inflation, low growth and revenue shortfalls making it extremely difficult for the country to reduce to debt to GDP level, even if the ECB maintains 10 year bond yields around 5%. <a href="http://www.ft.com/cms/s/0/315ed340-c72b-11e0-a9ef-00144feabdc0.html">Writing in the Financial Times</a>, International Monetary Fund managing director Christine Lagarde makes exactly this point. “We know that slamming on the brakes too quickly will hurt the recovery and worsen job prospects. So fiscal adjustments must resolve the conundrum of being neither too fast or too slow. Shaping a Goldilocks fiscal consolidation is all about timing. What is needed is a duel focus on medium-term consolidation and short-term support for growth and jobs", she said.
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<br />So we really do now have a very high risk stand-off, with Monsieur Trichet and his colleagues holding the whip hand for the time being, as the threat to take the finger out of that dike concentrates attention on the issue in hand. But this upper hand has a definite sell-by date looming if the implementation of the debt-brake principal in a context of global slowdown (or recession) proves too severe for Italian voters to accept. Then the Italian politician's fear of the penalty shot from someone on his own side might just become stronger, despite his apprehension before the technical superiority of M. Trichet's footwork. In which case, someone should remind them over at the ECB that, <a href="http://krugman.blogs.nytimes.com/2011/08/07/a-self-fulfilling-euro-crisis-wonkish/">as Paul Krugman puts it</a>, "once once a country takes on the fixed cost of default, it might as well impose a big haircut on creditors". As the United States discovered in Vietnam, it's easy enough to get yourself bogged down in a mess, but a lot harder to extricate yourself from one subsequently.
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<br />This post first appeared on my Roubini Global Economonitor Blog "<a href="http://www.economonitor.com/blog/author/ehugh3/">Don't Shoot The Messenger</a>".</p>Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-3949752.post-86559428367230930822011-08-16T21:29:00.000+02:002011-08-17T21:31:55.384+02:00Going Dutch - One Possible Solution To the Euro Debt Crisis?Looking back over the last 18 months of Europe’s debt crisis, European Central Bank Executive Board member Lorenzo Bini Smaghi <a href="http://www.ecb.int/press/key/date/2011/html/sp110708.en.html">recently invoked</a> Winston Churchill’s famous quip, “You can always count on Americans to do the right thing -- after they’ve tried everything else.”
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<br />Europeans too, he assured his audience would also get it right, eventually. Unfortunately all the coming and going, procrastination, denial and half measures we have seen since the Greek crisis first broke out have not come without a cost, and this cost can be seen in the growing lack of confidence in the markets that a lasting solution to the underlying problems of the common currency will finally be found. Only adding to the problems, even the Americans seem to be having difficulty finding the right thing to do this time round, or at least doing it at the right moment, as the market turbulence following the S&P downgrade has served to underline.
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<br />It’s probably too soon to say whether what Europe’s leaders are about to agree on what will ultimately be the “right thing”, but at least there now does seem to be a general recognition that a defining moment is fast approaching, and fundamental changes to the continent’s institutional structure are now on the table. Among the options now being openly advocated and debated is to be found a measure thought unthinkable a year ago -- ending Europe’s 13 year experiment with a single currency. But even if this ultimate possibility – the so called nuclear option – were to come to pass, as always there would be a right way and a wrong way of going about it.
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<br /><strong>Few Now Doubt The Gravity Of The Situation </strong>
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<br />The latest round in the European sovereign debt crisis has been, without a shadow of doubt, the most serious and the most potentially destabilising for the global financial system of any we have seen to date. Pressure on bond spreads in the debt markets of the countries on Europe’s troubled periphery have become so extreme that the European Central Bank (ECB) has been forced to make a radical and unexpected change of course, intervening with “shock and awe” in the Spanish and Italian bond markets. During the first week following the change in policy <a href="http://online.wsj.com/article/SB10001424053111903392904576510140739909936.html?mod=googlenews_wsj">the bank bought bonds worth a minimum of 22 billion euros</a>. To put this number in some sort of perspective, the entire bond purchasing programme to date for Greece, Ireland and Portugal has only involved some 74 billion euros, and this in over a year of intervention.
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<br />Along with earlier interventions in Ireland, Portugal, and Greece, the central bank has become the “buyer of last resort” of peripheral Europe’s bonds, but this can only be an interim measure, since the volume of bonds which would need to be purchased on an ongoing basis simply to stop the Spanish and Italian bond yields rising is so massive that it would put the bank well outside the limits of its original founding charter. It would also put the central bank in need of substantial recapitalisation should Italian and Spanish debt need to be restructured at some point.
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<br />And as if all this was not enough, adding urgency to difficulty even core countries like France are now finding themselves drawn into the fray, while the risk of contagion spreading to the East is now far from negligible. The French spread, the extra yield investors demand to buy 10-year French debt rather than German bunds, has jumped to 87 basis points, even though both carry AAA grades from the major rating companies. <a href="http://www.bloomberg.com/news/2011-08-10/french-aaa-credit-affirmed-by-standard-poor-s-moody-s-amid-market-rout.html">According to Bloomberg data</a>, this is almost triple the 2010 average of 33. Credit-default swaps on France now trade at around 175 basis points, more than double the rate for protecting German securities.
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<br />In addition pressure in both the US and Europe over the debt issue have lead other currencies like the Swiss Franc or Yen (in addition to gold) to very high levels, which in the case of the Franc has a direct impact on households and companies in those East European where borrowing in CHF has been prevalent. This surge in the Franc <a href="http://www.bloomberg.com/news/2011-08-04/hungary-squeeze-deepens-as-swiss-steps-to-curb-franc-fall-short.html">has already produced worrying repercussion in Hungarian financial markets</a> raising the spectre of contagion spreading to the East.
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<br />The gravity of the situation was highlighted when the European Commission President Jose Manuel Barroso <a href="http://in.reuters.com/article/2011/08/03/idINIndia-58605120110803?type=economicNews">explained to waiting reporters at the height of the latest crisis</a> that the current "tensions in bond markets reflect a growing concern among investors about the systemic capacity of the euro area to respond to the evolving crisis."
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<br />To be clear, the issue involved is no longer one of the mechanics of Greek debt restructuring, or of the extent of private sector involvement in any such debt adjustment, or even the of the value of the already agreed upsizing of the capacity of the European Financial Stability Fund (EFSF, the bailout mechanism). The current crisis is an existential one, which if left unresolved will rapidly become a matter of life of death for the single currency. In a portent of what may now be to come, at the very same moment in which the board of the ECB was reaching agreement on its latest programme of bond purchases <a href="http://www.dw-world.de/dw/article/0,,15300742,00.html">preoccupations were already being aired in Berlin</a> that the sums involved in a generalised rescue might be too large for even the richest countries in the core to accept.
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<br />In fairness to Mr Barroso, what he was suggesting was not that the Euro itself was on the verge of collapse, but that there had been a deep and significant shift in market perceptions of the crisis, and that this shift required a new and much more fundamental response from Europe's leaders and institutions. It is the capacity of these leaders to agree on even the broad outlines of a viable and effective response which is at the heart of all the market nervousness, and in this sense the recent decision by the rating agency Standard and Poor's to lower downgrade the US sovereign has only served to complicate further an already complicated situation.
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<br />So why this abrupt and dramatic change in the way the game is being played? Undoubtedly the lion’s share of the explanation is to be found in the arrival of a new, and to many unexpected, elephant in salons of European power. With something like 1.9 trillion Euros in outstanding debt, Italy is the planet's third largest issuer of sovereign bonds (following Japan and the United States) and although the relatively high savings rate of the Italian private sector (both families and corporates) means that much of the debt is in Italian hands, the deep interlocking of Europe's financial system (which is a by-product of the deep and liquid bond markets which came into existence following the creation of the common currency) means that a considerable portion is not.
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<br />In a certain sense the Italian crisis has crept up on market participants and caught them unawares. The reason for the relative unexpectedness of the scale of Italy’s problems is in part historical accident (that it was Greece, and not say Ireland, that got into trouble first) and in part a reflection of the need for market discourse to find a single and unified focus, and in this case the focus was on deficit and not debt. To put it simply, all too often market discourse could be described as suffering from some kind of “one track mind” syndrome.
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<br />The high profile given to the Greek issue meant that to a large extent Europe’s problems were perceived as being fiscal deficit ones, with more fundamental issues like lack of convergence, current account imbalances, cumulative debt and low economic growth all being pushed well into the background. Now things have changed. As <a href="http://www.eubusiness.com/news-eu/eurozone-finance.bpl">former UK Prime Minister Gordon Brown put it recently</a>: “Now no number of weekend phone calls can solve what is a financial, macroeconomic and fiscal crisis rolled into one”. Solving the crisis involves “a radical restructuring of both Europe's banks and the euro, and will almost certainly require intervention by the G2O and the International Monetary Fund”.
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<br /><strong>Historic Issue With The Euro</strong>
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<br />Perceived by many as being ill-gotten and ill-born, the issue of Euro parentage has long been a topic of intense debate and controversy, most notably between economists on one side of the Atlantic and those on the other, and between micro- and macroeconomists. There simply has been no consensus on what in fact the problem is, and criticisms from the United States of the way the crisis has been handled in Europe are often felt to be unfair and misplaced. As ECB Executive Board Member <a href="http://www.ecb.int/press/key/date/2011/html/sp110708.en.html">Lorenzo Bini Smaghi put it in July speech</a> to the Hellenic Foundation for European and Foreign Policy, in the United States a significant financial crisis does not call into question the whole institutional and political set-up, and the dollar itself is not considered to be at risk. In Europe, in contrast, a crisis is often considered by outside observers as putting the euro, and the Union itself, at risk of disintegration. “Academics and other experts deliberate on whether the euro area is viable and how it can be rescued. Closet eurosceptics suddenly reappear, dusting off their I-told-you-so commentaries”.
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<br />Whilst Mr Bini Smaghi undoubtedly puts his finger on the core of the issue in this statement, and most certainly reflects the level of frustration felt by key players in European decision making, analogies with individual states in the Union simply fail to get to the heart of the reason for much of the preoccupation. It is not simply a question of “closet” (or open) eurosceptics suddenly reappearing, but of the monetary union repeatedly showing fault lines exactly where many of those much berated macroeconomists had expected they might appear. This is why Mr Brown is undoubtedly right to focus on the fact that beyond an immediate fiscal crisis, what we have in Europe is also a crisis of macroeconomic management and of financial stability. As <a href="http://www.eubusiness.com/news-eu/eurozone-finance.bpl">he so eloquently puts it</a>, what many were worried about was the fact that the initial Euro design contained "no crisis-prevention or crisis-resolution mechanism and no line of accountability when things went wrong".
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<br />Naturally Gordon Brown is far from being the first to have voiced such views. The fact that economies in Europe’s core and those on the periphery far from having converged have actually been diverging under the watchful eye of ECB monetary policy has long been a cause for concern in macroeconomic circles. In particular, at the heart of the monetary union’s current problems lie the huge imbalances which have been generated between the economic “surplus” countries in the core, and the external deficit ones on the periphery. Europe’s leaders have long avoided biting the bullet, and indeed could be considered to be in deep denial, over the significance of this issue. Referring to the prevailing voices among European policymakers <a href="http://economix.blogs.nytimes.com/2011/06/02/the-french-determination-to-run-the-i-m-f/?hp">former IMF Chief Economist Simon Johnson put it this way</a>:
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<br /><blockquote>“I vividly recall discussions with euro-zone authorities in 2007 — when I was chief economist at the I.M.F. — in which they argued that current-account imbalances within the euro zone had no meaning and were not the business of the I.M.F. Their argument was that the I.M.F. was not concerned with payment imbalances between the various American states (all, of course, using the dollar), and it should likewise back away from discussing the fact that some euro-zone countries, like Germany and the Netherlands, had large surpluses in their current accounts while Greece, Spain and others had big deficits”.</blockquote>
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<br />The fig-leaf of Europe’s nations being somehow equivalent to US states has long been held up to justify the idea that the common currency was in general working well, and that the problems involved in managing it were being greatly exaggerated. With the arrival of the Italian elephant onto the centre stage at a stroke this argument has become as outdated as the institutional structure which lay behind it, since few of core Europe’s leaders are really willing to accept the responsibility for giving full and lasting guarantees for the country, quite simply because it is not just one more state in a fully integrated union, but a sovereign nation with all that that implies.
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<br />Having said this, there can be no doubt that Europe’s leaders have made huge strides forward in their attempts to get to grips with the issues as they have presented themselves, even if the measures taken so far continue to fall woefully short of what will eventually be needed. As the crisis has moved on from the initial concerns about Greek accounting methods, the piecemeal approach adopted by European policymakers has lead them to erect what is now a veritable production line of crisis resolution instruments and departments, with each of the needy patients being situated at different stages of the treatment process. In the Greek case the underlying issue is now acknowledged to be a solvency one and teams of experts are hard at work in a seemingly endless struggle to try to decide just what degree of restructuring (and/or reprofiling) Greek debt will finally need. In the Irish and Portuguese cases the task still remains one of monitoring programme implementation, with the focus being on whether or not they will eventually require (Greek style) a second stage bailout package. Meanwhile in the antechamber, the Spaniards and the Italians patiently wait their turn, while the doctors and health system administrators hold a heated debate as to whether there is enough space available in the emergency ward, and whether the patients have sufficient insurance to cover them should the surgery need to be drastic.
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<br /><strong>Too Big To Fail (Or Save)</strong>
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<br />What now brings a renewed sense of urgency to the whole process is the question of whether Spanish and Italian bonds could soon find themselves shut out of the financing markets in the way their smaller predecessors were before them. The latest ECB decision to intervene in their bond markets would seem to make it more rather than less likely that they eventually will be, since it is hard to see how they can now move back to unsupported market prices.
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<br />One of the curious anomalies about how the debate is currently being framed is the way in which banks and money funds who have invested in Europe’s periphery are being told that it is only right they should now assume some part of the anticipated debt restructuring burden due to their earlier policies of “irresponsible lending”, while these very same investors are also being urged to purchase new issues of just this very debt, on the argument that risk is exaggerated since the countries concerned have essentially sound economies, and are only suffering from short term liquidity and balance of payment type problems.
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<br />The underlying dilemma for such institutions has been highlighted by the decision of the Italian market regulator Consob to request information on the recent move by Deutsche Bank to reduce its exposure to Italian government debt. Banks have some responsibility to their clients, and will not normally knowingly take decisions which will lose money for them. So it is only rational for them to try to “lighten up” their positions on some of Europe’s weaker sovereigns. What isn’t credible is for political leaders to at one and the same time tell the banks that they are lending irresponsibly and urge them to purchase debt which may well end up being restructured. Thus the recent insistence on private sector involvement in Greek restructuring is often not unnaturally seen as one of the triggers for financial institution flight from Spanish and Italian bonds.
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<br />The Deutsche Bank case is a good illustration of the problem being faced by both the banks themselves and by those trying to maintain confidence and stability in the sovereign debt markets. <a href="http://www.reuters.com/article/2011/07/26/deutschebank-sovereigns-idUSLDE76P1G420110726">According to data from the bank’s quarterly results</a> it reduced its net exposure to Italian sovereign debt from 8 billion euros in December 2010 to 997 million euros at the end of last June. To put this in some sort of perspective, over the same period it cut its exposure to Spanish debt by some 53% (to 1,070 million euros) while the reduction in their Italian debt holdings was of the order of 87.5%. It is this difference in velocities of sell-off which in large part explains the recent surge in Italian bond yields, making it now potentially more expensive for Italy to finance itself than it is for Spain. And the reason for this is simple: previously Italy was seen as effectively isolated from contagion problems on the periphery, while Spain was not.
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<br />While yields on 10-year Italian government bonds have now fallen back significantly from their earlier euro-era highs, Spain’s have fallen further, and before the ECB intervention Italian yields had risen 1.26 percentage points since the end of June while Spanish yields had only risen by about half that amount.
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<br />Really the Italian situation is by far the most complex one facing the Euro system at this point in time. In the years prior to the outbreak of the financial crisis in 2007 Italy’s debt had long been a focus of attention among those who were worried about the effectiveness of the Euro Area’s Stability and Growth Pact whereby countries were expected to maintain deficit levels below 3% of GDP annually, and cumulative debt levels below 60% of GDP. In fact, according to IMF data, gross Italian government debt hasn’t been below 100% of GDP since 1991, and the country entered the financial crisis with a level of around 103% of GDP. During the crisis the country remained beyond the searching gaze of financial market interest by keeping its annual deficit at comparatively low levels, but a combination of recession, low growth and a substantial interest payment burden on the already accumulated debt has seen the level rise steadily to an estimated 120% of GDP this year.
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<br />Effectively Italy is poised on what is often termed a “knife edge”, since in order to stop this percentage snowballing upwards the country needed a growth rate in nominal GDP (that is uncorrected for inflation) of around 3% a year, and this at the rates of interest being paid before the recent surge. This effectively means a growth rate of 1% and an inflation rate of 2% (on average, and over a significant period of time). This growth number may not sound too ambitious, but <a href="http://econpapers.repec.org/paper/pardipeco/2006-ep01.htm">as the Italian economist Francesco Daveri points out</a>, Italy’s average annual GDP growth rate has been falling by around 1% a decade since the 1970s, and average growth between 2001 and 2010 was only around 0.6% per annum.
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<br />After falling by something like 6.5% during the crisis the Italian economy did manage to grow by 1.3% in 2010, but growth in the first half of this year has already been weak, while all forward looking indicators suggest it will be weaker in the second half. Thus analyst estimates of an eventual 2011 0.8% growth rate seems if anything optimistic, and with the IMF forecasting 1.9% inflation during the year, the numbers just don’t add up.
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<br />And that, of course, was before interest rates started to rise. While the new higher interest rates won’t have a huge impact in the short term, as existing debt needs to be steadily refinanced the extra cost will simply mount and mount. Which is why the Italian government is in a huge bind. It doesn’t have a debt flow problem, it has a debt stock problem, and as the risk premium charged on Italian debt rises and rises, and as the growth outcomes fail to meet the often optimistic targets, then the snowball of debt steadily slides its way down the mountain side with little the government can do to stop it growing as it moves. Like some modern Sisyphus, they are condemned to struggle with a monumental task where advance seems well nigh impossible. Out of good taste it would be better not interrupt them in their labours to ask whether, Camus style, they are still able to maintain a smile on their face.
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<br /><strong>They Ain’t Coming to Bailout, No..., No..., No..., No..., No!</strong>
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<br />Those who most definitely are not smiling at this point in time are German politicians and voters. <a href="http://www.spiegel.de/international/spiegel/0,1518,777671,00.html">As Christian Reiermann comfortingly informed Der Spiegel readers recently</a>: “The euro zone looks set to evolve into a transfer union as it struggles to overcome the debt crisis. There are a number of options for the institutionalized shift of resources from richer to poorer member states -- and Germany would end up as the biggest net contributor in every scenario”. These are emotive times, but feelings of outrage are not necessarily the most reliable guidelines to steer by in the search for durable solutions to complex problems.
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<br />The Italian hit may well be the most recent and the most spectacular the common currency has suffered in the 10 short years of its existence, and it may have created the problem which is quite literally too big to handle with the present institutional structure, but it really is only the latest example of that complex mix of fiscal, macroeconomic and financial issues that have come to plague the Euro which Gordon Brown draws attention to, and these issues do, by and large, go back to a design fault which was in there from the start. So while Europe’s unhappy families may all be unhappy for a variety of different reasons, the root of the problem is that the project as it was set up contained all the mechanisms for creating the problems, but few of the ones which would be needed for resolving them.
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<br />Large structural distortions were able to build up over the earlier years of the currency’s life, but now it is very hard to see where the much needed remedies are to come from. Some sort of fiscal union is now widely if belatedly seen as forming a necessary part of a well-functioning monetary union, but trying to introduce one at this stage in the game, when many of the countries along the periphery have suffered a substantial competitiveness loss in relation to those in the core seems to lead to only one conclusion, the kind of transfer union that so worries Christian Reiermann and so many of his fellow citizens.
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<br />Europe already has examples of just this kind of transfer union between higher growth and richer regions and their lower growth and poorer neighbours in Germany, Italy and Spain, and in no case can it be said that such arrangements have proved popular with those who are asked to be the net contributors. So it is not hard to reach the conclusion that this kind of fiscal union would be simply unsustainable in the Euro Area context at the present time.
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<br />The only real way forward is for those who have lost competitiveness to somehow regain it. This, as we are seeing, is far easier said than done. Most of the proposals which have come from the EU Commission and the IMF to date involve some kind of micro-level productivity-enhancing structural reforms, but these are not able to raise growth rates sufficiently quickly (indeed there is very little real evidence of the extent to which they are able to do this in any event), and inevitably involve the countries involved trying to “out-Germany” the Germans, which culturally on the face of it seems to present them with an almost impossible challenge, especially when German companies are hardly marking time themselves.
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<br />Normally, the classic solution in this situation would have been some kind of devaluation, but obviously these countries have no currency left to devalue. Another possibility would be the kind of “internal devaluation” process which has been tried in the Baltics, and a number of macroeconomists (myself included) have been arguing for this, but the complete lack of any kind of positive response makes the viability of even this approach hard to contemplate, and anyway, systematic deflation would in many cases only make the debt problem worse.
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<br /><strong>Euro At The Crossroads</strong>
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<br />So the Euro is now at the crossroads, and important decisions need to be taken. Preserving the Eurozone -- as it is now -- might be workable if it were possible to transform the Eurozone into a full fiscal union where budgetary policy was coordinated across nations by a central treasury in the way major programmes are between states in the US. But such an arrangement is a now a political impossibility, as Europe’s core economies would inevitably reject what would be seen as a permanent transfer union between high-growth regions and their poorer neighbours.
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<br />However the present debate about creating Eurobonds is resolved, these alone will not solve the problem at this point, and, as many observers are noting, may even make matters worse by weakening the sovereign credit ratings in the core. In the longer run they could form part of a more general solution, but the moral hazard dimension they entail means that in the absence of a fix for the immediate competitiveness problems on the periphery they only risk making the common currency project even more politically unstable. Such is the price for so much procrastination and denial. As <a href="http://www.ft.com/intl/cms/s/0/b620280c-b9ef-11e0-8171-00144feabdc0.html?ftcamp=rss#axzz1U9HjkmrV">Citibank’s Chief Economist Willem Buiter so delicately put it recently</a>, attempts to transform the current bailout mechanisms into a transfer union would be doomed to failure since “the core euro area donors would walk out and the periphery financial beneficiaries would refuse the required surrender of national sovereignty”.
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<br />So, with fiscal union effectively off the table, there are basically three possibilities. The first is to stay more or less where we are, maintaining and even expanding the bond purchasing programme of the ECB, and simply trying to hang on in there. The stability fund could be increased, but the more numbers start being accounted in detail the further away the various parties get from being able to agree. If this continues the ECB is likely to reach a ceiling beyond which it will be more than reluctant to continue buying, since the bank takes the view that the resolution has to come from the politicians.
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<br />But with Italy and Spain’s combined sovereign refinancing needs between now and the end of 2012 totalling something like 660 billion euros, and the financing needs of the banks to take into account on top, reaching agreement to expand the bailout mechanism on this scale looks like a pretty improbable outcome, especially when you consider that once you are that far in you will simply have to continue all along the road. So at some point the spreads will start to widen again as markets force the issue, with the inevitable outcome that the monetary union is pushed towards the brink of breakdown.
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<br />The second possibility would be to disband the union entirely, leaving everyone to go back to their own national currency. This would be a disastrous outcome for all concerned, and for the global financial system. Coordinating the unwinding of cross country counter liabilities would be a nightmare given the level of interlocking in the corporate and sovereign bond markets, and the sudden disappearance of one of the major global currencies of reference would cause havoc in financial markets. The dollar would most likely be pushed to unsustainably high levels in the rush for safety, and it is only necessary to look at what is currently happening to gold, the Swiss Franc and the Japanese Yen to catch a glimpse of what would be in store.
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<br />Evidently this kind of violent unwinding would never be undertaken voluntarily, but that does not mean that it is an eventuality which might not take place, if solutions are not found and the force of market pressure continues and even augments.
<br />Fortunately there is a third alternative, even if it is one that at first appears no more appetising than either of the other two: the Eurozone could be split in two, creating two different euro currencies. Naturally the composition of the groups would be a matter of negotiation, since some countries do not easily belong in either one group or the other. The broad outline is, however, clear enough. Germany would form the heart of one group, along with Finland, Holland and Austria.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiWeCHMpbMZ2yu9_cE0RP4adBeT2zs3yYm-ocuJssPAkYyCS4dbICOr0NjlzZwGzRyZfXcPKB51Y5tku1uzqvw4oZ3ibhXY4lKldvPdTgiwyANvor8fYH-Pd6u0qaj9y4-969cGDw/s1600/The+Hanseatic+league.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 298px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5641100602323260786" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiWeCHMpbMZ2yu9_cE0RP4adBeT2zs3yYm-ocuJssPAkYyCS4dbICOr0NjlzZwGzRyZfXcPKB51Y5tku1uzqvw4oZ3ibhXY4lKldvPdTgiwyANvor8fYH-Pd6u0qaj9y4-969cGDw/s400/The+Hanseatic+league.png" /></a>
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<br />In addition Estonians have been making it pretty that they would also be up for the ride. Spain, Italy and Portugal would naturally form the nucleus of the second group, with Slovenia and Slovakia being possible candidates. Some countries, Ireland and Greece for example, might simply choose to opt out.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg-03QQXUKX_0GOcCnZfuAU91NGa9d1KJh_0cmFN7gieYVFv5-FRZ40eT6OQqieoaWddKawN_t7QVsBo6G3wB2GkMzo4axVGnpBmBf6HrxCQJzMfmHcC6GHYPXdu5zG44RGSeb0hg/s1600/The+Med+Climate.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 270px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5641099872667993538" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg-03QQXUKX_0GOcCnZfuAU91NGa9d1KJh_0cmFN7gieYVFv5-FRZ40eT6OQqieoaWddKawN_t7QVsBo6G3wB2GkMzo4axVGnpBmBf6HrxCQJzMfmHcC6GHYPXdu5zG44RGSeb0hg/s400/The+Med+Climate.png" /></a>
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<br />The big unknown is what France would do. In many ways it belongs with the first group, but cultural ties with Southern Europe and political ambitions across the Mediterranean could well mean the country would decide to lead the second group. Naturally if what was involved were not ultimate divorce but temporary separation, then French participation with the South would also have a lot of political rationale. The term Franco-German axis would gain a whole new meaning.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh2Mz0dOEZwMF4HpOgR7nIVqzkaK8wd2vuylq5eR3N7rVjENYNjDLjA5J6hhRnFUJZctErmSixQxxabli1DkrNd31lUBDi2rnpR4ZcPiifPJ90sLLO8S9w7xrgDZvffPcn_HS7aag/s1600/Current+Accounts.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 278px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5641101631457763746" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh2Mz0dOEZwMF4HpOgR7nIVqzkaK8wd2vuylq5eR3N7rVjENYNjDLjA5J6hhRnFUJZctErmSixQxxabli1DkrNd31lUBDi2rnpR4ZcPiifPJ90sLLO8S9w7xrgDZvffPcn_HS7aag/s400/Current+Accounts.png" /></a>
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<br />Naturally the technical challenge would be enormous, but it would not be insurmountable. The great advantage of such a move would be that two of the major burdens under which the monetary union is labouring – the lack of price competitiveness on the periphery and the lack of cultural consensus between the participants - would be resolved at a stroke.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEheckWxPFgO1OVQzKEm_R613TArNFYNNyXDp86d0430Ky9XsFjsdUNFWMrel_acSwWwGjlbdJFvGx2Ni7o91MgTsrotQFvACIberu5McYThFjHfFeJjHcLOlE9lRY4FODsOSHck8A/s1600/REERs.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 281px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5641102056953261234" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEheckWxPFgO1OVQzKEm_R613TArNFYNNyXDp86d0430Ky9XsFjsdUNFWMrel_acSwWwGjlbdJFvGx2Ni7o91MgTsrotQFvACIberu5McYThFjHfFeJjHcLOlE9lRY4FODsOSHck8A/s400/REERs.png" /></a>
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<br />No one knows the values at which the two new currencies would initially operate, but for the purpose of a thought experiment let’s assume a Euro1 at around U.S. $1.80 (the euro/USD is currently around US$ 1.40), and a Euro2, at around $1. Obviously, in the short term the winners of this operation would be the members of Euro2, who would get the devaluation their economies have been yearning for. Why would this be? At a time when the countries concerned are loaded down with debt and domestic demand is correspondingly weak, export growth is the only way for their economies to move forward, and the change would allow cheaper labor and production costs, giving them an enormous push in this direction.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgZh7T2OgoONvqAAlne8dsfH_eGDvJEmHBKmqBkNb0dP0afl10w_oAWqtee7_nysReZYJFT0If2ZFO1sLdYYEwFZzAlvsT7ek7z_OBmW9aTnofwi_KSbhjoZpN3fSUCx_G-4ZW_9w/s1600/Inflation.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 289px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5641102519974413506" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgZh7T2OgoONvqAAlne8dsfH_eGDvJEmHBKmqBkNb0dP0afl10w_oAWqtee7_nysReZYJFT0If2ZFO1sLdYYEwFZzAlvsT7ek7z_OBmW9aTnofwi_KSbhjoZpN3fSUCx_G-4ZW_9w/s400/Inflation.png" /></a>
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<br />And it would encourage growth in other ways. Take Spain as an example. The country has at the present time a large pool of surplus property, on many estimates of around 1 million unsold new housing units. Many have criticised the banking sector for not dropping prices sharply to enable the market to clear, but the banks are understandably reluctant to do this due to the impact this would have on their balance sheets, and due to the knock-on effect on their existing mortgage books. The beauty of this solution is that no further drop in price would be needed, since for external buyers the real price of all this housing would suddenly become much cheaper.
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<br />The case of tourism would be somewhat similar, since not only would more tourists come to Spain, they would come for longer and they would spend more. The shopping bags would certainly not be empty on the plane home.
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<br />Spain’s troubled savings bank sector has been desperately looking for foreign investors to help them recapitalise, but while many have shown interest virtually none have participated to date. After the devaluation all this would change since they would be able to buy shareholding at attractive prices, and without having to worry about a sudden drop in prices and hence loss of capital.
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<br />Spain’s 4.5 million unemployed would gradually start to go back to work, new investment could steadily be attracted for other productive projects in manufacturing industry, no one would doubt the solvency of the Spanish state, and the private sector would be in a better position to start paying back its debts as the economy grew.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgP55_fNIMR2bKBy2YTBHMYWOpHvgGX8xLRQbkEEZDrnBl0gWV41nWGTcB5HoX_I-gNGKb-tx4C8OXi0rn2Z6nVufUJg7hNN_xKzta_l7nPk02qvI-uDVTJoDH5MOtAkNC1tyHJdQ/s1600/Two+Tier+Euro.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 273px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5641102972457204034" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgP55_fNIMR2bKBy2YTBHMYWOpHvgGX8xLRQbkEEZDrnBl0gWV41nWGTcB5HoX_I-gNGKb-tx4C8OXi0rn2Z6nVufUJg7hNN_xKzta_l7nPk02qvI-uDVTJoDH5MOtAkNC1tyHJdQ/s400/Two+Tier+Euro.png" /></a>
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<br />Now obviously, as we all know, in economics as in life there are no free lunches, so there must be a catch here somewhere, and of course there is. In fact there are two big “catches”. In the first place those countries who joined together to form Euro1 would be making a big sacrifice, since many of them also depend on exports for their livelihood, and their manufacturers would suddenly and sharply find themselves at a disadvantage. In particular Germany would suffer.
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<br />However, assuming that all can agree at some point that the current arrangements are unworkable, and that going back to individual national currencies would be a disaster, then the German sense of responsibility and the country’s commitment to the European project might well make the acceptance of some sort of sacrifice (and especially if it were a sacrifice which offered longer term solutions) bearable. Fortunately, recent German historical experience provides us with two concepts which might just help everyone see their way through this. The first of these is the Treuhandanstalt, the Privatisation institution (and bad bank) which was created to handle East German assets between 1990-1994. The second is Lastenausgleich, or burden sharing, and this refers to the mechanism which was used to share the unequal outcome of WW II between Germans who found themselves living in the West: between those who had come from the East and lost everything and those who were from the West and had retained something.
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<br />The Treuhandanstalt experience is useful in helping us to think about how to handle the common set of assets/liabilities acquired during the initial Euro stage. Think about Spain’s banks and their property assets. These would now be sold in Euro2, but many of the liabilities which correspond to them are in fact liabilities with institutions who will find themselves in Euro1. Marking them to market immediately, and in Euro2, would produce sizeable losses in the Euro1 financial sector. Some of these losses are inevitable and to some extent correspond to the kind of restructuring haircuts which are now being contemplated. But in the initial period (and for reasons which will become clearer below) it would be advisable not to mark them to market, but to hold them for a specified time in a common institution of the Treuhandanstalt kind.
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<br />As I say, some losses are now inevitable, and this is where the second concept from recent historical experience – Lastenausgleich, or burden sharing – becomes important. Despite protests to the contrary from Lorenzo Bini Smaghi (link) the Euro experience to date has not been a success for any of the participants once you add-in the potential losses which are now looming. At the same time the common currency has been a shared experience, in which all have taken part, so it is not unreasonable to assume that all should share when it comes to the downside. The problem with the measures adopted to date is that they are perceived on both sides of the fence as unfair. Those who are funding the bailouts feel that they are being asked to pay for the “excesses” of the recipients, while those who receive feel that what they are getting is not help, but loans which make it easier for the financial sector in the donor countries to avoid declaring losses. This “communicational impasse” is one of the major reasons the current approach won’t work.
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<br />What is needed at this point is an appeal to the European spirit of the Euro1 countries, in a way which helps them to see that some costs are unavoidable, but that any agreed costs will be shared, and above all that the game-changing solution is workable and offers some sort of constructive positive future for all Europeans. Put in other words, what we need is a mechanism which contains both realism and idealism in just sufficient proportions.
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<br />The advantage that the split Euro option has over all the other proposals on the table at the present time is that it would address the growth issue head on. The countries on Europe’s periphery could return to growth, and once the economies involved start growing rather than shrinking the proportion of the liabilities incurred during the earlier period which they will be able to pay rises significantly. It is much more difficult to collect debts from an unemployed household than it is from one which is gainfully employed.
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<br />Another attractive feature of this proposal is that no “in principle” decisions would need to be taken about the long term structure of the European financial system. The ECB could be retained as a kind of holding entity and clearing house for the outstanding financial mismatch, and the current national central banks could be grouped into two separate sub-entities. This would leave open the possibility of reconvergence at a later date should conditions obtain which would make the move viable. The first stab at creating a currency union has failed, but this doesn’t mean that any possibility of creating one in the future should be abandoned. Hard and costly lessons have been learned, and what is now needed is a full and open discussion of the reasons for failure, precisely to avoid similar mistakes being made in the future.
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<br />Having the move co-ordinated by pan-European institutions has another advantage, and that is to do with the degree of conditionality the process must involve. Devaluing their currency would, as I have suggested, give a great short term boost to growth in countries along the periphery, but this short term boost would only be converted into a long term sustainable improvement in trend growth if a lot of other things were done too. It is very easy to laud the great advance Argentina made on breaking the dollar-peg, but look where Argentina is today. This “short sharp shock” treatment only has a lasting impact (as it did in Scandinavia in the 1990s) if measures to improve institutional quality (reformed labour and product markets, productivity and innovation drives) are implemented and maintained. Here again partnership is needed, since while giving back to the periphery “ownership” over its own reform programmes would be another significant advantage of the arrangement, the reform process would need to remain under the auspices of a common European project, one which could lay the basis for a consensually grounded lasting political union, a union which would be the essential precondition for any future attempts to move back towards greater monetary integration.
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<br />Effectively Europe’s leaders are caught in a kind of Pavlovian trap. There are no easy choices, although there are good ones and bad ones. Staying where they are leaves them in a kind of permanent electric shock zone where their constant feeling of failure only serves to further deteriorate their own sense of personal and political worth. Advancing also seems painful, but more than the intensity of the shock it is the sensation of fear and angst which dominate. Still there is no alternative but to advance, since you cannot stay where you are. Simply applying administrative measures to force stability onto a financial system which resists with all its might will only result in increasingly destabilizing behaviour (read “speculation”) by the agents within the system. Administrative fiat simply represses and pushes forward instability (read” kicks the can down the road”), leading the system itself to become ever more inefficient. In any malfunctioning financial system, as the late Hyman Minsky famously said, “stability is itself destabilizing”.
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<br />Perhaps it is appropriate to close this essay where it started, with a quote from ECB Board member Lorenzo Bini Smaghi: “as J.K. Galbraith observed: “<em>Politics consists in choosing between the disastrous and the unpalatable</em>”. To see disaster looming before choosing the unpalatable is a dangerous strategy”.
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<br />This article is an expanded version of one which was originally published on the website of the US magazine Foreign Policy, under the title "<a href="http://www.foreignpolicy.com/articles/2011/08/09/the_euro_and_the_scalpel">The Euro and the Scalpel</a>"
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<br /><strong>Appendix - The Way To Split The Euro</strong>
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<br />This article was written during 4 days I spent in Marbella earlier this month in the home of my friend and colleague Detlef Gürtler (author of the recent book Entschuldigung! Ich Bin Deutsch (<a href="http://www.bloomberg.com/news/2011-07-03/bullying-germany-s-economic-whip-endangers-european-union-survival-books.html">Sorry, I'm German</a>, Mermann Verlag GmbH, Hamburg).
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<br />While I was busying myself with the text, Detlef was working on the images (which can be found above), and on some illustrative material for the technical side.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjw5oyMu-prcAHsMXE5TjBLaZtcX9nFqB-32XNUnVmdclxo-Xq22Zd54R4Q8OJibiSZhNZGyUHVrPS1p8XMuxEa7ePcz7UkUeTlS34YOMfikD53nYXkIASYQ9u3puT4NMHaFLqf_w/s1600/Number+One.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 176px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5641111613709607842" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjw5oyMu-prcAHsMXE5TjBLaZtcX9nFqB-32XNUnVmdclxo-Xq22Zd54R4Q8OJibiSZhNZGyUHVrPS1p8XMuxEa7ePcz7UkUeTlS34YOMfikD53nYXkIASYQ9u3puT4NMHaFLqf_w/s400/Number+One.png" /></a>
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<br />These graphics only give some illustration of just how complex any unwinding of the commen currency would be, given how interlocked the financial sectors of the participating countries have become.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiIiAaLqE93E_pR7qRs0iyCtsGnQIdL9-MxqfrwIoQPzte7MZYlibRDpg7MR3glI86wDB7Bk6dYMBlFG8VvkN2nfUSve4mD2QrL4qQpsX9FvDmPvBHOvYh1lSRUyoxlCH0dbCizgA/s1600/Number+Two.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 258px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5641111535133147810" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiIiAaLqE93E_pR7qRs0iyCtsGnQIdL9-MxqfrwIoQPzte7MZYlibRDpg7MR3glI86wDB7Bk6dYMBlFG8VvkN2nfUSve4mD2QrL4qQpsX9FvDmPvBHOvYh1lSRUyoxlCH0dbCizgA/s400/Number+Two.png" /></a>
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<br />Some sort of holding entity would need to accept responsibility for a whole range of problematic assets during any transitional period. This entity could be the ECB. The though behind the idea that not everything should be marked to market immediately is that the Euro2 countries are nothing like so weak as the initial value of the new currency would suggest, nor are the Euro1 countries so strong as is often thought. So inevitably the parity at which the two would exchange would converge towards a much tighter band, which would be much closer to the real competitiveness difference between the various countries. Naturally it would make a lot more sense to mark to market at this point, since the losses to be borne on both side would be that much smaller.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjhZyShui7suY5ZLB5W-B7g3UbM5r5pE8sJFAHsXoHBztMHaH2V3tWI4qLAsAllihPItyO2kgIrDee8H_yDHjoYHarZAcU8JoLrQrFCVFW0jiXTgEHCdUGOecbbXxo2i2sp8hGnmw/s1600/Number+Three.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 263px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5641111470043714562" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjhZyShui7suY5ZLB5W-B7g3UbM5r5pE8sJFAHsXoHBztMHaH2V3tWI4qLAsAllihPItyO2kgIrDee8H_yDHjoYHarZAcU8JoLrQrFCVFW0jiXTgEHCdUGOecbbXxo2i2sp8hGnmw/s400/Number+Three.png" /></a>
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg4yKronr7E9MUXh1QjZ3-pRGr1Qy04vHFze6ycV03520Th7BWwfgthy6oJfDjhZwekQRRto6LD2cxZgvUCw31-jHZ0FS78z40LUT1jivvhhyphenhyphen59M2-XmpKdLIAVI7impQx6y67xUQ/s1600/Number+Four.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 271px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5641111405024988946" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg4yKronr7E9MUXh1QjZ3-pRGr1Qy04vHFze6ycV03520Th7BWwfgthy6oJfDjhZwekQRRto6LD2cxZgvUCw31-jHZ0FS78z40LUT1jivvhhyphenhyphen59M2-XmpKdLIAVI7impQx6y67xUQ/s400/Number+Four.png" /></a>
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiVG7RAnJoGNARyxhgztNvmaqAsMbm8O93yty1JEx1198YZWVn-iwS-kuGmBL9Q2W6bXYtvZof9Uyb0o7bZI1JXmk9YSjkiq6mT0AEqH5T3moR_3tVTMbb4ug-NDbCiOlxTvxU3TA/s1600/Number+5.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 274px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5641111317696471666" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiVG7RAnJoGNARyxhgztNvmaqAsMbm8O93yty1JEx1198YZWVn-iwS-kuGmBL9Q2W6bXYtvZof9Uyb0o7bZI1JXmk9YSjkiq6mT0AEqH5T3moR_3tVTMbb4ug-NDbCiOlxTvxU3TA/s400/Number+5.png" /></a>
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<br />It is also worth stressing that this solution is far from perfect. We do not live in an ideal world. It is only one possible way of breaking the vicious circle into which the Euro Area countries have now fallen. It is one possible way, and as far as I can see the only viable and realistic one.
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<br />This post first appeared on my Roubini Global Economonitor Blog "<a href="http://www.economonitor.com/blog/author/ehugh3/">Don't Shoot The Messenger</a>". Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-3949752.post-69404001643710276322011-07-25T18:30:00.000+02:002011-07-25T18:31:16.404+02:00Recession Warning On Europe's PeripheryAs Europe’s leaders struggle to convince markets that their Greek debt problem-resolution-proposals are actually viable, and will really do the trick, last week's flash PMI readings seem to have attracted rather less attention than they might. Nonetheless, the fact of the matter is that it is steadily becoming clearer that the current slowdown in Eurozone economic growth is turning into something more than just another one of those pesky “soft patches”. The pace of economic expansion in core Europe has slowed dramatically, falling back in July for the third consecutive month, according to the latest flash PMI. Commenting on the flash results Chris Williamson, Chief Economist at Markit said: “The Eurozone recovery lost almost all of its momentum in July, recording the weakest growth since August 2009 when the recovery first began. Excluding the financial crisis, the July survey was the most downbeat since the Iraq war in 2003, and consistent with a flat trend in quarterly gross domestic product.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiLf78-OfvCuWVmdfxxl90hJx6V8ByqrVGg2iNGI4QuEXbc62ho5gBb0X0tblHicltE2P0JvcuvEzLG6m-kQGmMm_vOzCGLRIA7n4Kfp_xeYGc5bXPYR6n6PbX9Lj54pAOXIxokzQ/s1600/Eurozone+Composite.png"><img style="text-align: center;margin: 0px auto 10px;width: 400px;height: 229px;cursor: hand" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiLf78-OfvCuWVmdfxxl90hJx6V8ByqrVGg2iNGI4QuEXbc62ho5gBb0X0tblHicltE2P0JvcuvEzLG6m-kQGmMm_vOzCGLRIA7n4Kfp_xeYGc5bXPYR6n6PbX9Lj54pAOXIxokzQ/s400/Eurozone+Composite.png" border="0" alt="" /></a><br /><br />In fact the rate of expansion – the composite indicator registered just 50.8, only slightly above the dividing line between growth and contraction - was the lowest since August 2009, when the recovery was just starting out. More importantly (for the longer term) new business coming in showed only a very marginal increase in July, registering what was the smallest rise since demand for manufactured goods and services first started to return to growth back in September 2009. Levels of incoming new business fell in manufacturing for the second month in a row, declining at the fastest rate since June 2009 – with new export orders actually falling for first time since July 2009.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiaHs92s-7sLG4KqnatAzOO7f63D7v2WWPgdce-3ss_ajNwgyGDfzEIDr3nAFLdRze_NkNnWyCWkJRNBYWL7TKp875d3110jUaodHCnvddn5kQt_05LFbf1kBlKXJZxjILP8SnwXg/s1600/Eurozone+New+Business.png"><img style="text-align: center;margin: 0px auto 10px;width: 400px;height: 240px;cursor: hand" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiaHs92s-7sLG4KqnatAzOO7f63D7v2WWPgdce-3ss_ajNwgyGDfzEIDr3nAFLdRze_NkNnWyCWkJRNBYWL7TKp875d3110jUaodHCnvddn5kQt_05LFbf1kBlKXJZxjILP8SnwXg/s400/Eurozone+New+Business.png" border="0" alt="" /></a><br /><br />What this means, of course, is that the slowdown has now extended, spreading deep into the heart of the core, with both services and manufacturing in both Germany and France affected.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhPVo_gOAS3lHiEQqmxQaKLRqDOcLWrALZDkKspu0k3grCeUSqYKqRPtwSxrb8Ddz5vScErwladh35rUdcu9zylCAB9UJNiyx60Vyo3UxzJdbL-v3nEoEhU60ayEy6_n0WBllsuoQ/s1600/german+composite.png"><img style="text-align: center;margin: 0px auto 10px;width: 400px;height: 216px;cursor: hand" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhPVo_gOAS3lHiEQqmxQaKLRqDOcLWrALZDkKspu0k3grCeUSqYKqRPtwSxrb8Ddz5vScErwladh35rUdcu9zylCAB9UJNiyx60Vyo3UxzJdbL-v3nEoEhU60ayEy6_n0WBllsuoQ/s400/german+composite.png" border="0" alt="" /></a><br /><br />The German composite index fell to 52.2, from 56.3 in June, and while the latest reading still remained comfortably above the 50.0 no-growth value, the month-on-month index fall of 4.1 points was the largest since the November 2008 post Lehman drop. Tim Moore, Senior Economist at Markit said in his report “Almost in the blink of an eye, German private sector output has gone from rapid growth to a slow crawl.<br /><br />But even as growth in the core economies approaches stall speed, out on the periphery a new recession seems increasingly on the cards, and most importantly in countries like Spain and Italy which have so far managed to keep their heads just above the waterline. Growth in the second quarter of the year looks likely to have been minimal in both cases, and the outlook for the third quarter suggests we are entering a bout of economic shrinkage.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjA_NUTqb3ooiQzGhPO8WYpSA1MvadeJjY9Ei7nCRY_P1HstJFkYpdmxXYAiZt3wh0R0cnxM8k4Eqo_r_RF4Vdd6y7F4lq_ALbMNkzPpFQLeQGnaknXkRtdErOx3Ozj2SllnxQlmA/s1600/Core+versus+periphery+output+flash.png"><img style="text-align: center;margin: 0px auto 10px;width: 400px;height: 251px;cursor: hand" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjA_NUTqb3ooiQzGhPO8WYpSA1MvadeJjY9Ei7nCRY_P1HstJFkYpdmxXYAiZt3wh0R0cnxM8k4Eqo_r_RF4Vdd6y7F4lq_ALbMNkzPpFQLeQGnaknXkRtdErOx3Ozj2SllnxQlmA/s400/Core+versus+periphery+output+flash.png" border="0" alt="" /></a><br /><br />The PMI readings also coincide with the impression offered by monetary indicators.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgCiNPuIAD4fJJZf-W5YCgfLHpePrDgB66-x9YmW42c8CO56evOWeB7vYMJJjs34iNvBe7dwy4q-KFwVUJ1EAMMxtdcALA1h4dQRppK9gb86sNo-mJgfw9XzFOlxfemsvn6FicQ_Q/s1600/Euro+Real+Deposits.png"><img style="text-align: center;margin: 0px auto 10px;width: 400px;height: 234px;cursor: hand" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgCiNPuIAD4fJJZf-W5YCgfLHpePrDgB66-x9YmW42c8CO56evOWeB7vYMJJjs34iNvBe7dwy4q-KFwVUJ1EAMMxtdcALA1h4dQRppK9gb86sNo-mJgfw9XzFOlxfemsvn6FicQ_Q/s400/Euro+Real+Deposits.png" border="0" alt="" /></a><br /><br />As <a href="http://www.moneymovesmarkets.com/journal/2011/7/12/italian-woes-reflect-monetary-weakness.html">Henderson Global Investors’ Simon Ward points out</a>, in late 2010, while real (ie inflation adjusted) current bank deposits were contracting in Spain and Italy, they were still growing robustly in both Germany and France, implying a solid economic growth economic outlook in the core for the first half of 2011 (this monetary indicator is often thought to give an indication of activity with a 6 month lag).<br /><br />But currently, as can be seen in the above chart (which shows rates of six monthly growth) real deposits have even started to contract in the core, while in Italy the rate of shrinkage has accelerated considerably, suggesting that the earlier “two-speed” Eurozone recovery may now be about to give way to a period of much more generalised weakness, reinforcing the impression given by the PMI order indexes. What is most striking is the way Italian M1 deposits have been contracting much more strongly than Spain’s have of late, although this development should not take us completely by surprise, since, as I have been consistently pointing out (see <a href="http://www.economonitor.com/edwardhugh/2011/06/27/red-lights-flashing-for-eurozone-growth/">here</a>, <a href="http://www.economonitor.com/edwardhugh/2011/06/29/can-italy-grow-its-way-out-of-debt/">here</a> and <a href="http://www.economonitor.com/edwardhugh/2011/05/22/is-italy-not-spain-the-real-elephant-in-the-euro-room/">here</a>) it has been clear from both real and survey data for some months now that Italy was heading towards recession again.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiTQXVIuREh_QW9WAS87fbQFeyO97evOQdZf-aKSaZpYiLdtxuO33tg18k5O6taC6yHF3Dt_LMdgwTIh71fXVz7FyTjtaTgNmuL58olTyHlyeSeOBTbPKHaIxzo-kHaML4fYsMlEw/s1600/Euro+Periphery+Real+Deposits.png"><img style="text-align: center;margin: 0px auto 10px;width: 400px;height: 249px;cursor: hand" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiTQXVIuREh_QW9WAS87fbQFeyO97evOQdZf-aKSaZpYiLdtxuO33tg18k5O6taC6yHF3Dt_LMdgwTIh71fXVz7FyTjtaTgNmuL58olTyHlyeSeOBTbPKHaIxzo-kHaML4fYsMlEw/s400/Euro+Periphery+Real+Deposits.png" border="0" alt="" /></a><br /><br />And looking at the second monetary chart that Simon provides, it is evident that the weakness in Spain and Italy forms part of a much more general contractionary phenomenon on the periphery, but then I imagine that the idea that Greece and Portugal might be in recession comes as a surprise to no one.<br /><br /><strong>Part of a Bigger Global Picture</strong><br /><br />Of course, the vulnerability we are seeing on Europe’s periphery is being played out in the context of a global economy which is itself clearly losing momentum. This generally weakening in global growth has been clear from the evolution in the global manufacturing PMI for some time now.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhKFjC1o8Ch1HsTDtuFWTo09al_g9FvLx91ZQXQ-96WAqf_T3Qwwkye33-5Wsto00DvWYryEAg61YYVVvgjpLqIA0OWjFG0XZCjf530azSzJ2VhUd1VrJc5Uxwzy8PzJDcFCk-xDw/s1600/JP+Morgan+Global.png"><img style="text-align: center;margin: 0px auto 10px;width: 400px;height: 226px;cursor: hand" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhKFjC1o8Ch1HsTDtuFWTo09al_g9FvLx91ZQXQ-96WAqf_T3Qwwkye33-5Wsto00DvWYryEAg61YYVVvgjpLqIA0OWjFG0XZCjf530azSzJ2VhUd1VrJc5Uxwzy8PzJDcFCk-xDw/s400/JP+Morgan+Global.png" border="0" alt="" /></a><br /><br />And the latest China manufacturing flash PMI (which showed contraction for the first time since the middle of 2010) suggests the ongoing pattern will be once more confirmed in July, with global manufacturing moving closer to the critical 50 dividing line which marks the frontier between growth and contraction.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjJyfUT7Y2RSvXxnuMuuMlMFWI2WozJALciPzhKl2D_etMoa6DyNzmi8cu58j6NEo8XvrPh_1oksaOhzRNATeRTttTF7fGjvwlHV6b-kVtDY0kaMXPIxcc7xkFdlKhA03iqlWDISw/s1600/china.png"><img style="text-align: center;margin: 0px auto 10px;width: 400px;height: 220px;cursor: hand" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjJyfUT7Y2RSvXxnuMuuMlMFWI2WozJALciPzhKl2D_etMoa6DyNzmi8cu58j6NEo8XvrPh_1oksaOhzRNATeRTttTF7fGjvwlHV6b-kVtDY0kaMXPIxcc7xkFdlKhA03iqlWDISw/s400/china.png" border="0" alt="" /></a><br /><br />Even more importantly the Chinese export order component (which could be considered as a long leading indicator giving us information about possible activity levels three to six months from now) reinforced the idea that the slowdown is likely to be extended in time.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjWvMyigGzhZ7MkjH_hSyW1e-fdTtRB8Yf5AAXtehHlNrob9f50bBsSDjqvk2Fg1MaQLKBZKG3EIkSoORRrX_Sj2MvVavrBy9x459pZKtnfw6jBAhvHcM9qwRIYFZRKGjXi-SloBQ/s1600/China+Export+Orders.png"><img style="text-align: center;margin: 0px auto 10px;width: 400px;height: 190px;cursor: hand" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjWvMyigGzhZ7MkjH_hSyW1e-fdTtRB8Yf5AAXtehHlNrob9f50bBsSDjqvk2Fg1MaQLKBZKG3EIkSoORRrX_Sj2MvVavrBy9x459pZKtnfw6jBAhvHcM9qwRIYFZRKGjXi-SloBQ/s400/China+Export+Orders.png" border="0" alt="" /></a><br /><br />This impression (of an extended period of lower growth globally) is also confirmed by the business expectations component of the German IFO. I would about anticipating an early termination of the slowdown till we see some real sign of sustained improvement in Chinese new export orders and a solid uptick in IFO expectations.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgudkWQNFHlwrgud3Hr5k92m6N8KL0lrUsQPe2E3Mpr8Xfbuq_IVryHhyphenhyphenYx8Nm40ECK0yJb0QhadIgTJKZe9yVyShegBHaFlflfX9sU5UXvY_a2iN_QTjaXmO0BHbbXJlUQhgewwA/s1600/IFO+expectations+chart.png"><img style="text-align: center;margin: 0px auto 10px;width: 400px;height: 264px;cursor: hand" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgudkWQNFHlwrgud3Hr5k92m6N8KL0lrUsQPe2E3Mpr8Xfbuq_IVryHhyphenhyphenYx8Nm40ECK0yJb0QhadIgTJKZe9yVyShegBHaFlflfX9sU5UXvY_a2iN_QTjaXmO0BHbbXJlUQhgewwA/s400/IFO+expectations+chart.png" border="0" alt="" /></a><br /><br /><strong>So Why Don’t We All Be Just That Little Bit More Vigilant?</strong><br /><br />Where does all this that leave Europe in policy terms? Well, in principle recent developments in the real economy should present the ECB with significant monetary policy dilemmas, given the risks to the integrity of the monetary union that could result from a combination of reform/recession weariness out on the fringe and bailout fatigue in the core. Evidently the slowdown will make it harder to meet deficit targets in Spain and Italy, and will most likely mean there is a need for new measures which will become harder and harder to sell to voters, while any deterioration in the jobs market in Germany (we should be watch the unemployment numbers in Germany in the coming months) could well make bailout contributions harder to drum up. As <a href="http://www.hussmanfunds.com/wmc/wmc110725.htm">John Hussman put it in a note to investors this morning</a>:<br /><br /><blockquote>"As I've noted several times in recent months, bond market spread imply very low near-term (3-6 month) probability of default in any Euro-area country. A sovereign default is much more likely to occur near the end of the next bear market, whenever it occurs, than at the start. As Ken Rogoff and Carmen Reinhart noted in their book This Time It's Different, "Overt domestic default tends to occur only in times of severe macroeconomic distress." The most likely window for a Greek (or other Euro-nation) default will be at a point when France and Germany are experiencing economic downturns sufficient to douse the political will to bail out their neighbours at a cost to their own citizens".</blockquote><br /><br />So in theory what these leading indicator readings should be telling us is that we should expect little more in the way of rate rises during what remains of 2011. Continuing to raise rates into an economic slowdown where there are clear risks of financial instability would not seem to be sound monetary policy.<br /><br />In addition, given the way the pace of manufacturing input price inflation now seems to be cooling rapidly (see chart below), it would not be surprising to see a change the wording of the risk assessment for price stability from ‘on the upside’ to ‘balanced’ at the next meeting. This would avoid a lot of potential communication difficulties in the months to come, and would open the door up to a much more flexible interest rate policy.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgX3avHYWQDR0GXdxGsP1EP_ltOYkDuc8RDpyB3bMN64jLODjttDNwbRnypJQLaG1xozD5bPpG679z8x6LR0U5BF2JR1cjz8qVqsCgG2mfdJQx0O8nX2kqIbbcbfpyCepmRaI8Q2w/s1600/Core+versus+Periphery+Flash+Output+Prices.png"><img style="text-align: center;margin: 0px auto 10px;width: 400px;height: 251px;cursor: hand" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgX3avHYWQDR0GXdxGsP1EP_ltOYkDuc8RDpyB3bMN64jLODjttDNwbRnypJQLaG1xozD5bPpG679z8x6LR0U5BF2JR1cjz8qVqsCgG2mfdJQx0O8nX2kqIbbcbfpyCepmRaI8Q2w/s400/Core+versus+Periphery+Flash+Output+Prices.png" border="0" alt="" /></a><br /><br />One critical point to grasp is that the ECB decisions themselves have now become one of the main factors which will influence the outcome of the slowdown, not simply via the standard monetary policy path on Europe’s core economies but via the impact its decisions will have on policy sustainability on the periphery, and though this channel on the level of global risk sentiment.<br /><br />In this sense ensuring economic growth is not the only distraction which could divert the ECB’s attention from its principal mandate in defence of price stability, since there is also debt stability to think about too. Recent days have show that large peripheral economies like those of Spain and Italy, far from having totally decoupled from the smaller and weaker countries, are now once more being drawn back into the maelstrom.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiTMbg6YMCu1pJYrzFAj3PX0URtKckoftBwMiPfQUeX246IBzUMz8cmmUQVDx9lqMvPA5mXW3l6ugOjc9cAHIRXf6pRKxig6w7Sx_lhUtFyKMYHNuOcr1SZNRlxvput56nKQAT5cw/s1600/Italy+Spain+spreads+Two.png"><img style="text-align: center;margin: 0px auto 10px;width: 400px;height: 219px;cursor: hand" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiTMbg6YMCu1pJYrzFAj3PX0URtKckoftBwMiPfQUeX246IBzUMz8cmmUQVDx9lqMvPA5mXW3l6ugOjc9cAHIRXf6pRKxig6w7Sx_lhUtFyKMYHNuOcr1SZNRlxvput56nKQAT5cw/s400/Italy+Spain+spreads+Two.png" border="0" alt="" /></a><br /><br />In particular Italy’s government debt to GDP level of 120% has been attracting growing attention. Simple calculations show that just to stabilise debt at this level with the previous prevailing interest rates the country needed a 3% annual growth in nominal GDP. Now, of course, they are likely to need slightly more. But real GDP growth this year will be significantly under 1%, while all those earnest efforts by the ECB to push the country’s inflation rate down below 2% will simply serve to help nudge the debt level upwards, in the process raising the premium investors will ask to buy Italian debt, with the implication that next year the country will need an even higher rate of nominal GDP growth, and so on, and so forth.<br />And the situation is Spain is hardly better, with 85% of mortgages being attached to variable rates, pushing Euribor upwards simply starts to weaken the hitherto comparatively robust performance of the bank mortgage books, while the slower economic growth will make government deficit targets even harder to maintain.<br /><br />So really, the issue is not whether the ECB was right to go ahead with this months rate rise given its main mandate, the issue is whether members of the Governing Council could by any chance prove themselves sufficiently flexible in the future to change their discourse in the face not just of Greek default woes, but also of heightening recessionary and debt management risks? In his report just before the last rate meeting, Deutsche Bank’s Gilles Moec argued that the situation was “not bad enough” for the Bank not to raise. I wonder if the deterioration we have seen since that time makes it “now bad enough”? Just how bad do things have to get for us to reach that point, and just what is prudent and what is risky behaviour in current circumstances? Certainly Council members need to be vigilant, but in particular they need to be vigilant that their attempts to avoid one problem do not inadvertently generate another, even more difficult to handle, one.<br /><br /><br />This post first appeared on my Roubini Global Econmonitor Blog "<a href="http://www.economonitor.com/blog/author/ehugh3/">Don't Shoot The Messenger</a>".</p>Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-3949752.post-35183676174833224782011-07-03T19:33:00.001+02:002011-07-03T19:42:41.900+02:00Can Italy Grow Its Way Out of Debt?What follows is simply a follow-up note to my earlier (<a href="http://www.economonitor.com/edwardhugh/2011/05/22/is-italy-not-spain-the-real-elephant-in-the-euro-room/">Elephant in The Euro Room</a>) piece on Italy. The decision by S&P to put Italian sovereign debt on negative outlook, and the subsequent announcement by Moody's that it was considering a downgrade has been widely commented on by analysts, and it might be interesting to take a look at some of the views that have been advanced on either side of the argument (although for the detailed analysis see me earlier post). But first, a summary of the problem.<br /><br /><strong>Chronicle Of A Crisis Long Foreseen<br /></strong><br /><br />The first thing to be absolutely clear about is that this issue is not new. As FT Alphaville's James Coterill notes: "In the original ‘why the eurozone will break up’ papers of the 1990s and early 2000s, it was never ever high Greek deficits, or Irish (or Spanish) bank losses going on to public balance sheets that were forecast to destroy the single currency. It was always Italy. High-debt, low-growth, Italy".<br /><br />As <a href="http://www.nytimes.com/2010/06/09/business/global/09blogger.html">the New York Times' Landon Thomas noted in the Blog Prophet of Eurozone Doom</a> article he wrote about my work, "Mr. Hugh’s demographic thesis is not airtight: in fact, it was Italy, not Greece, that attracted his early attacks. But Italy, perhaps because its overall debt level was already so high and its population was older, pursued a policy of greater fiscal rectitude than its neighbors and avoided a real estate bubble".<br /><br />Not airtight, but nearly-so it seems, since behind the short term focus on fiscal rectitude there lies the longer term preoccupation about solvency and debt. and here Italy (and eventually Japan) jump right back into the cockpit. As Landon mentions, Italy didn't have a housing boom worthy of mention, so private debt didn't surge during the first decade of the century, and during the crisis Finance Minister Tremonti pursued a policy of flying under the radar by keeping deficit spending low. But now short term deficit issues are waning, and longer term solvency questions are surfacing in the wake of the renewed Greek crisis. Thus, while historians of the future may well struggle to understand just how it was that a simple fiscal deficit bailout programme was so badly handled that Greek sovereign debt shot up from around 110% of GDP entering the crisis to around 170% by the end of the "rescue" period (and this without even having enjoyed a real housing bubble, ie with a private sector that was not massively in debt), the Italian case will raise few eyebrows, since every thinking economist had seen it coming for so long (Japan too, see my Italy blog <a href="http://eurowatch.blogspot.com/2005/11/promises-promises-but-more-than.html">here</a>, <a href="http://italyeconomicinfo.blogspot.com/2007/07/credit-rating-agencies-pensions-ageing.html">here</a>, <a href="http://italyeconomicinfo.blogspot.com/2006/09/wolfgang-munchau-and-eurozone.html">here</a> and <a href="http://italyeconomicinfo.blogspot.com/2007/06/macroeconomic-adjustment-in-euro-area.html">here</a>).<br /><br /><strong>The Knife Edge Problem<br /></strong><br />The issue in hand is not too hard to grasp, even for those little tutored in economics. Italy's gross public sector debt stood at approximately 120% of GDP in 2010. This is already too high, since it is significantly past the critical 100% level widely considered to be "the point of no return if not handled carefully" one. And how did it get there is the question we may want to ask. Was the high debt level due (as is the case in Ireland) to an emergency bank bailout, or was the country struggling (the Japan case) to fend off entrenched deflation?<br /><br />No, there were none of these exceptional (or mitigating) circumstances to take into account, we are simply faced with a series of governments that were persistently (and mainly due to the burden of accumulated interest charges) paying out more than they were receiving in income, for over more than a decade, and turning a deaf ear to all the warnings being offered. It is always heartening to hear Mr Tremonti telling us that he will clamp down on administrative excesses and politicians salaries, or that he will wage a war on tax evasion, but really it would be interesting to know why he is always just on the point of doing something decisive to solve Italy's revenue raising issues, but somehow never actually does.<br /><br />As the Irish Finance Minister Michael Noonan <a href="http://online.wsj.com/article/SB10001424052702304447804576409620313655208.html">said in an interview at the weekend</a>:<br /><br /><br /><br /><blockquote>"In Ireland, if you decide to tax bar stools and you give that instruction to the Revenue Commissioners [tax authorities] there will be a tax and there will a yield," he said. "Their collection does not seem to be very good and it is a matter of speculation as to whether they can fulfil the commitments they are making or not," he added.</blockquote><br />He was talking about Greece, but Italy obviously suffers from similar tax collection issues when it comes to tracking down the informal economy.<br /><br />Basically, the Italian case is something of a hybrid one, since it is a bit like Portugal in its inherently low trend growth rate (significantly under 1% per annum) and like Greece in the tax execution problems it faces. In common with all the Mediterranean countries it also faces a great challenge when it comes to getting politicians to set aside party-politiking in order work together in the common national interest.<br /><br />So Italy is now in the hot seat, since the focus of investor attention is moving beyond short term deficit control problems, and towards long term debt sustainability ones. Italy, as Barcap's Antonio Garcia Pascual put it, is on the "knife edge".<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiljm-ZkTorkEZ5VJvnPvOfbpXcL2yFBqk0iXqYq-CnUCLUe2qhiD4oaUzIj4p9BRbJ1X5wid7PuJmsgq5Df-k3f8DLet_-0DoZhGgi6jDj3R5f9HfQXfse67u3-z4YnBA6t4N7bA/s1600/Italy+Knife+Edge.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; HEIGHT: 206px; CURSOR: hand" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiljm-ZkTorkEZ5VJvnPvOfbpXcL2yFBqk0iXqYq-CnUCLUe2qhiD4oaUzIj4p9BRbJ1X5wid7PuJmsgq5Df-k3f8DLet_-0DoZhGgi6jDj3R5f9HfQXfse67u3-z4YnBA6t4N7bA/s400/Italy+Knife+Edge.png" /></a><br /><br />And basically this isn't going to be a story which needs a very long timeline to resolve, over the next few years either Italy's public debt level will move downwards to 118%, 116%, 114% of GDP etc (and people start to breathe more easily) or it will carry on up towards 122%, 124% and 126% etc, in which case Italy will need to seek shelter in the new European crisis mechanism (if things hold together for long enough for it to be put in place), and the debt will have to be restructured (the Euro <strong>was</strong> a costly little experiment, now wasn't it?). This is the basic gist of the argument behind <a href="http://www.reuters.com/article/2011/06/17/us-italy-moodys-instant-idUSTRE75G5FJ20110617">Moody's recent announcement</a> that they were thinking of downgrading the Italian Sovereign rating, since the risks that Italy is going to need restructuring are rising.<br /><br />Of course what really put the cat among the Italian pigeons, was <a href="http://online.wsj.com/article/BT-CO-20110623-710627.html">Moody's subsequent announcement that it was putting 16 Italian banks on rating watch negative</a> for possible downgrade due to their exposure to the Italian sovereign. Thus, in the blink of a press release was put to the test and found wanting a nice little theory that held that Italian public debt wasn't such a big deal, since it is mainly held by Italian banks. Exactly, and precisely for this reason it is a big deal for Italian banks, at least two of which could be considered systemic. Hence <a href="http://www.google.com/url?sa=t&source=newssearch&cd=2&ved=0CEcQqQIwAQ&url=http%3A%2F%2Fwww.bbc.co.uk%2Fnews%2Fbusiness-13904785&ei=h0wHTu2gH8uq-AbNzbXpDQ&usg=AFQjCNHm-Vvh8c2FIH6m8uTa_Dazili1xw">the debacle on Friday on the Italian bourses</a>.<br /><br />So as Garcia Pascual says, Italy is sitting on a knife edge, or looking out over a precipice. Really there are only three things that matter - the rate of GDP growth, the rate of inflation, and the level of interest payments. Unfortunately for Italy, the first two of these are falling at the moment (see <a href="http://www.economonitor.com/edwardhugh/2011/06/27/red-lights-flashing-for-eurozone-growth/">this piece on current risks to Italian growth</a>), while the third is rising. Just last Friday, following the news that Moody's were reviewing the rating of the Italian banks, the spread on Italian 10 year bonds over equivalent German bunds hit 213 basis points, a Euro era record.<br /><br />As I have already stressed in the "<a href="http://www.economonitor.com/edwardhugh/2011/05/22/is-italy-not-spain-the-real-elephant-in-the-euro-room/">Elephant In The Euro Room</a>" piece, it is nominal GDP (or the sum total of real GDP plus inflation) that matters, and on existing interest rates the sum total of these two needs to be on average around 3% simply to maintain the debt were it is. Looking at the growth position, and the waning inflation as the global economy turns down, this level is unlikely to be achieved in 2011, so we will have our first evidence of "slippage". The longer term problem is that these two variables, in the case of an economy like the Italian one, work in opposite directions, since (given that Italy's economy is by and large export dependent for growth), in a currency peg structure more inflation means less peer-economy competitiveness, which means less growth. As Goldman Sachs economist Kevin Daly put it in a recent report:<br /><br /><br /><br /><blockquote>“For countries attempting to address these twin imbalances (government debt and current account deficit) within a currency union, there is a ‘Catch 22’ situation: competitiveness can only be regained via real exchange rate adjustment (i.e., by running lower inflation than the Euro-zone average). However, in order to boost public sector finances, economies need stronger nominal GDP growth and, thus, relatively low inflation (or deflation) has the effect of exacerbating the public-sector deficit problem. In other words, it is difficult to address one imbalance without exacerbating the other, and vice versa”.</blockquote><br />So that's the first part of the problem. But there is more. If we go back to Garcia Pascual's original baseline scenario chart, he assumed that the spread on Italian government debt would be about 100 basis points, in which case a nominal GDP growth rate of just under 3% and a budget deficit of just over 3% would stabilise Italian debt at around 120% of GDP. But the Italian spread just moved over 200 basis points, and in a post Greece-restructuring-event environment it is likely to go up, and not down, in which case, instead of stabilising, the debt will veer upwards, just on the increased country interest risk element alone.<br /><br />Then again, you might say, Italy could go for a serious austerity programme (of the Estonian "let's show these guys we're serious" type), going well under the 3% deficit target, and even trying to obtain a general budget surplus. Surely this would bring the debt down, and increase investor confidence (thus bringing the spread down). Well, yes, it might raise confidence but look what has just happened to Greece and is happening to Portugal now. Apply more austerity to a fundamentally uncompetitive economy and you are liable to seriously reduce growth, and even send the country into quite deep recession (Italy is, in my opinion, already near slight contraction). On top of that you have the danger that along with the austerity you will introduce another "indignados" movement, something which is more or less predictable in Italy's deeply divided political environment. At which point the Euro would surely be "rockin and rollin".<br /><br />All of which takes us back to the structural reforms issue as the great white hope on which so many people stake their bets that Italy will see it though.<br /><br />Of course, whether markets will continue to provide Italy with sufficient financing depends not only on macroeconomic and fiscal fundamentals, but also on factors that are outside of Italy’s control (such as investors’ appetite for European debt). The country’s outstanding level of public debt is high and fiscal discipline in the recent past had been preceded by less controlled public spending. And although economic activity in Italy has been sluggish, we continue to believe that the government’s stated goal of continuing to impose fiscal discipline will suffice to keep the country on a sustainable debt path.<br />Natacha Valla, Goldman Sachs<br /><br />"In an environment of low nominal growth, Italy‟s high interest payments (of around 5% of GDP) will continue to weigh on debt dynamics. However, we expect the primary balance to turn into a surplus from 2011 onwards, which should help to stabilise the debt to around 120% of GDP over the next two years.Having said that, determined action to implement growth-enhancing reforms and further fiscal consolidation to reduce the structurally high expenditure components is essential".<br />Lavinia Santovetti, Nomura<br /><br /><br /><br /><blockquote>We agree with S&P, as we stated several times in Focus Europe, that Italy needs to intensify its efforts on structural reforms to boost its disappointing GDP growth. It is important that the strength of the private sector does not become an excuse for complacency. Productivity-enhancing reforms would increase the likelihood of meeting the post-2013 Government’s fiscal objectives......Given that fiscal consolidation remains a fairly consensus strategy across the main parties and the tangible strength of the Italian private sector, we remain positive about the stability of the Italian public debt. The key risk in the short term is a political mistake in dealing with the European peripherals.<br />Marco Stringa, Deutsche Bank</blockquote><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEirNv7GdR0jmfz5CbdW3NM1-kU5mQ1UsFq3n3dWyzxz9HSg5seGombfGsRszM4ZwwtnYB51jGRfllHI2eIEpfCebah3mI7e403xxdOvfLTHgXUJCqy6d-lZUqfX1NeW3sqaYCNHVA/s1600/italy+long+term+GDP.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; HEIGHT: 196px; CURSOR: hand" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEirNv7GdR0jmfz5CbdW3NM1-kU5mQ1UsFq3n3dWyzxz9HSg5seGombfGsRszM4ZwwtnYB51jGRfllHI2eIEpfCebah3mI7e403xxdOvfLTHgXUJCqy6d-lZUqfX1NeW3sqaYCNHVA/s400/italy+long+term+GDP.png" /></a><br /><br />Of course, it is always a worthy option to live in hope, but looking at the evolution in Italian trend growth over recent decades, mightn't we do better all assembling in the Piazza San Marco one afternoon and getting down on of knees for half an hour, just to show we were really earnest in our hope.<br /><br />The key thing about all these ardently solicited structural reforms is that they need time both to implement and to work, and time (as I explained above) is just what Italy now hasn't got a lot of at this point (debt to GDP will either go up, or come down, and if it starts to go up.....).<br /><br />Back in June 2005 (when there was still plenty of time) the ECB hosted a conference with the interesting title "<a href="http://www.ecb.int/events/conferences/html/emu.en.html">What effects is EMU having on the euro area and its member countries</a>?" Among the papers present was one from two OECD economists (Romain Duval and Jørgen Elmeskov). The title of the paper was "<a href="http://www.ecb.int/events/pdf/conferences/emu/sessionIV_Elmeskov_Duval_Paper.pdf">The Effects Of EMU On Structural Reforms In Labour And Product Markets</a>", and the key finding was that:<br /><br /><br /><br /><blockquote>"As concerns the role of the monetary policy regime, the absence of monetary policy autonomy seems to be associated with lower structural reform activity in large, more closed economies".</blockquote><br />Put in plain English, in a country like Italy, monetary union had slowed down rather than speeding up the much needed structural change. At the time of publication the paper caused quite a stir, but, like so many useful things, was soon forgotten. As if foreseeing the paper's fate, the authors close with the following lament: "It would be sad if structural reform were eventually driven by a factor that empirically is strongly correlated with reform: crisis."<br /><br />Life it seems is inherently sad, and here we are now 6 years later, in the midst of the correlate they foresaw as their downside scenario, and still battling with all the same old problems, where the only light we can see at the end of the tunnel is that of the next express train hurtling down the track towards us.<br /><br />This post first appeared on my Roubini Global Econmonitor Blog "<a href="http://www.economonitor.com/blog/author/ehugh3/">Don't Shoot The Messenger</a>". <br /><p></p>Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-3949752.post-89864186269857516412011-05-22T15:53:00.000+02:002011-05-22T15:58:41.757+02:00Is Italy Not Spain The Real Elephant In The Euro Room?Looking through the latest round of EU GDP data, one thing is becoming increasingly obvious: when it comes to future monetary policy decisions at the ECB, and to exactly how many more interest rate hikes we are going to see, then the performance of the Italian economy is going to be critical. The growth pattern now is clear enough: Germany and France move forward at a lively pace, while the so called "peripheral" economies (Portugal, Ireland, Greece, and Spain) either remain in or continually flirt with recession. They are constrained bythe combined burden of their lack of international competitiveness, their over-indebtedness and the contractionary impact of their austerity programmes.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi90yuQGdthZ0Cg8FonKigXubONhv65Fcu6gIrqsmx3cxYiQ8vZ3Bn02dI5TpxTX-NJh4FYonog4jucXh2igZ06Db6du7_pddOJxE1FPkxgWuzeNWSXuVLweCtUwVaMviTCFLeirQ/s1600/Core+versus+Periphery.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 240px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi90yuQGdthZ0Cg8FonKigXubONhv65Fcu6gIrqsmx3cxYiQ8vZ3Bn02dI5TpxTX-NJh4FYonog4jucXh2igZ06Db6du7_pddOJxE1FPkxgWuzeNWSXuVLweCtUwVaMviTCFLeirQ/s400/Core+versus+Periphery.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604290144047065778" /></a><br /><br />In this sense, given its size, Italy is in a key position to tip the balance between core and periphery one way or the other. And the fact that, growth in the Italian economy seems once more to be grinding to a halt is not good news in this sense, with the quarterly gowth rate falling back from a quarterly 0.6% in Q2 2010, 0.5% in Q3, 0.1% in Q4 and 0.1% again in Q1 2011.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgpjb3jL1xxb2NktLq_wDCihrYzgYWkCkD1wgO84V1V6I7Eip0VKMm8pIFzwdWHyuxw-IuOmc-rUgSWwEidBLGx_A9KYHWfzWvCa9hUYpO02I9yXl-BcznDsFW5qcDvb_qmpzP2XA/s1600/GDP+Three.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 229px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgpjb3jL1xxb2NktLq_wDCihrYzgYWkCkD1wgO84V1V6I7Eip0VKMm8pIFzwdWHyuxw-IuOmc-rUgSWwEidBLGx_A9KYHWfzWvCa9hUYpO02I9yXl-BcznDsFW5qcDvb_qmpzP2XA/s400/GDP+Three.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5607267433115408514" /></a><br /><br /><b>Slow Growth Champion?</b><br /><br />I suppose it shouldn't really have surprised anyone to find that Italy’s GDP growth rate continued to slip back in the first three months of this year - both in absolute terms and with respect to core Europe - since Italy's average growth rate during the first decade was only about 0.6% per annum. It shouldn't have surprised, but I'm sure it did, since the financial markets have only been thinking of how comparatively low the Italian deficit has been since the start of the crisis, rather than worrying their heads off about how a country with such a low growth rate and such a high pending elderly dependency ratio is ever going to pay down the already accumulated debt. Italy's debt to GDP ratio is currently just short of 120%, while the population median age is 45, so lets just say Italy is Japan without the current account surplus.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhb5zOkvx6e8PzP8rIez3E5ddMMYi7azdR_2nedJPLEK7EGhjPXEAF8XnZj4unHekxRiHlJCG2Ls8M6EFM0l-p9mzXM_0H7Z_wLkjXS9zL-munJYb6VtKpBBRwQumAIyFV62akfSg/s1600/italy+long+term+GDP.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 196px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhb5zOkvx6e8PzP8rIez3E5ddMMYi7azdR_2nedJPLEK7EGhjPXEAF8XnZj4unHekxRiHlJCG2Ls8M6EFM0l-p9mzXM_0H7Z_wLkjXS9zL-munJYb6VtKpBBRwQumAIyFV62akfSg/s400/italy+long+term+GDP.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5609212295387461202" /></a><br /><br />Now were the quarterly GDP growth rate not to accelerate beyond the 0.1% expansion achieved in the first three months of this year, then even the current IMF forecast for modest 1% GDP growth in 2011 would start looking very optimistic. And if the country now slips back into recession (certainly not excluded) then the under-performance would be much greater.<br /><br /><b>Some Do Not Also Rise</b><br /><br /><br />The Italian result contrasts sharply with the strong performance in the main components of core Europe, emphasising yet again that despite the fact that it is managing to stay clear of bond market wrath at the moment, Italy essentially forms part of the low-growth high-public-sector debt economies on Europe's periphery. Both German and French real GDP growth in Q1 2011 came in much stronger than expected, with the former posting an impressive 1.5% quarterly increase (6% annualised), significantly stronger than the 0.9% expected by the markets, while French GDP increased by 1.0%, in this case with a strong contribution coming from domestic demand which was reflected in a strong increase in imports, imports which in theory should have benefitted Italy.<br /><br />France and Germany are in fact Italy’s main trading partners, accounting between them for about a quarter of Italy’s total exports. So although we do not have a breakdown of Italian Q1 GDP yet, the above developments point to a stagnating domestic demand only partially compensated by stronger net exports.<br /><br />The most recent results mean that German GDP has now passed its pre-crisis peak, while Italian GDP is still stuck at the level it reached at the end of 2004. The chart below (which comes from a recent report by PNB Paribas economist Ken Wattret ) shows the path of constant price GDP in the four largest eurozone countries (plus the UK) relative to where they were in Q1 2008. France is in a similar position to Germany, since fourth quarter 2010 GDP was around 1.6% lower than its pre-crisis peak, and it just rose by 1%.<br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj0VuHzp3VrAYtN7r5yQu42OsLwFAyigG7XFqYgTp2I6JkLzd7N-uR_vlkcUieAPC3cn6NG4bJKVl74DbBOZEWI5Pd29KAssxi_d50GfWVgkrn7doUVNVS7vs2x7aRQI9Qywmwh4Q/s1600/Italy+GDP+Comparison.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 302px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj0VuHzp3VrAYtN7r5yQu42OsLwFAyigG7XFqYgTp2I6JkLzd7N-uR_vlkcUieAPC3cn6NG4bJKVl74DbBOZEWI5Pd29KAssxi_d50GfWVgkrn7doUVNVS7vs2x7aRQI9Qywmwh4Q/s400/Italy+GDP+Comparison.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5609156231812649586" /></a><br /><br />The picture in the other countries, however, is very different. In Italy, Spain and the UK, GDP is currently 5.2%, 4.3% and 4.1%, respectively, below the peak levels reached in Q1 2008. So what accounts for the differences? In the German case the strength of the rebound is in-part a by-product the exceptional depth of the recession there. Between March 2007 and March 2008, German GDP collapsed by a cumulative 6.6%. This compares with peak-to-trough GDP declines of around 3.5% and 2%, respectively, during the recessions of the early 1990s and during the first years of the present century.<br /><br /><b>The Italian Economy Resembles The German One, Consumption Is Weak And Growth Depends On Exports: Unfortunately The Italian Economy Is Not Competitive Enough For This To Work</b><br /><br />Germany’s strong export dependency, and consequent high sensitivity to fluctuations in global trade, is the key reason why the country goes from strong growth to deep recession and back again (in fact quarterly GDP growth in Q1 2008 was 1.4%, just before the economy fell into recession). This dependency is reflected in the unusually high share of GDP which is accounted for by exports (over 50%), and may well be associated with the unusually high median population age of 45. <br /><br />As can be seen in the chart, the cumulative contractions in GDP in the other large European economies were typically significantly smaller than in Germany, even in a country like the UK which was extremely vulnerable to problems in the financial sector. A similar picture can be found in the US, where problems in housing and the banks formed a central and archetypical feature of the global crisis, even though GDP declined by only a cumulative 4% from peak to trough, two-thirds of the German drop.<br /><br />On the other hand, the Italian case offers an evident exception to the idea that the harder they fall the steeper they rise. The cumulative decline in Italian GDP from its Q1 2008 peak to the Q2 2009 trough was nearly 7% - making the output loss bigger even than that experienced in Germany. <br /><br />But the rebound has been much less impressive than the German one, with GDP still nearly 5% below the pre-crisis high, and basically still on the level of Q4 2003. In large part, this situation is a result of the weak performance of Italian exports. In Germany, exports are now back above their pre-crisis peak, while in Italy exports are still more than 14% under their Q1 2008 high point (See chart).<br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhw6RvBNK-ufhZHscobdWCxe0VICw6mipLh6JGWNQY-XhjcSHdAOfcUl1NEVP7XiQG_NpcWCCswBbzxsKGQ9il9aVRoNcWWSB1xlQJF6-ZG8B9H2LKAyP0wC4uH5kDu_W59Q7k_eA/s1600/Italy+Export+Comparison.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 316px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhw6RvBNK-ufhZHscobdWCxe0VICw6mipLh6JGWNQY-XhjcSHdAOfcUl1NEVP7XiQG_NpcWCCswBbzxsKGQ9il9aVRoNcWWSB1xlQJF6-ZG8B9H2LKAyP0wC4uH5kDu_W59Q7k_eA/s400/Italy+Export+Comparison.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5609239585460951010" /></a><br /><br /><b>Productivity Is The Key</b><br /><br />Average quarterly growth in German GDP since the economy bottomed in Q1 2009 has been nearly 1%, while in Italy, it has averaged under 0.3%. The geographical composition of German and Italian exports is one factor which influences the relative export performance between the two countries. The share of German exports which go to faster growing developing markets like China, has accelerated sharply since outbreak of the crisis, while Italy is still largely dependent on developed - and heavily indebted - economies. In addition Italy has a major competitiveness problem. Incredibly, and according to Eurostat data, in the first decade of this century the Italian hourly productivity index only climbed by 0.75%, while the German one climbed by 13.3%. That is to say, German productivity was up an average of 1.3% a year over the decade, while Italian productivity barely moved, rising only 0.07% a year. As a result, rising wages meant that Italian unit labour costs surged sharply. So, during the first decade of the Euro the Italians paid themselves more for producing virtually what they were producing at the start of the century. Naturally this is not sustainable.<br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgAdt91tCc6sKs0EpWWmOZ0vuy32WcMJcg3GNBjhB-V4ElpU5sq0ybJ0b9snArscF9UIplRxmxegNf1Zuy2VA8L5eU6cElGRTLe2mDDAl9x5cNBnETIC24k4P5B5QG9A39-BWv63w/s1600/Italy+and+Germany+Unit+Labout+Costs.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 223px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgAdt91tCc6sKs0EpWWmOZ0vuy32WcMJcg3GNBjhB-V4ElpU5sq0ybJ0b9snArscF9UIplRxmxegNf1Zuy2VA8L5eU6cElGRTLe2mDDAl9x5cNBnETIC24k4P5B5QG9A39-BWv63w/s400/Italy+and+Germany+Unit+Labout+Costs.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5609434052250197890" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh3o3A1EMgxJUXmSpvf6rtreX0O3aychkv7nH39IQhfpAyc3lbAdnXq3sRNpbbNNQ3p1F1BswcGc9F_HzqVHQpLlPIw2nAieDOi86r623wtFjtVZnKu-KJ_aQI75sWIK6A4t96JQw/s1600/Italy+%2526+germany+Productivity.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 224px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh3o3A1EMgxJUXmSpvf6rtreX0O3aychkv7nH39IQhfpAyc3lbAdnXq3sRNpbbNNQ3p1F1BswcGc9F_HzqVHQpLlPIw2nAieDOi86r623wtFjtVZnKu-KJ_aQI75sWIK6A4t96JQw/s400/Italy+%2526+germany+Productivity.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5609433958961462850" /></a><br /><br /><b>Labour Inputs Shoot Up, But Output Doesn't</b><br /><br />The situation is even more incredible if you take into account the fact that during these years the labour force grew steadily, and the country received several million new migrant workers. Between 2002 and 2010 the number of non-Italian citizens officially residing in Italy was up by 3 million (or 200%).<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhEzTZJFu9kahjCHnyyJ8_lq-HbzRn6DlbcK0ZpGJWfEpFDsRUe6V32aq8Q93kBPLhsgasDAjZvvF9wIsAFuw7MOAw5UCp6h3GNKCDq4ULaeGAKtSoYVEsHdzlBIs32aU0UkIxHIg/s1600/Italy+foreign+population.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 223px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhEzTZJFu9kahjCHnyyJ8_lq-HbzRn6DlbcK0ZpGJWfEpFDsRUe6V32aq8Q93kBPLhsgasDAjZvvF9wIsAFuw7MOAw5UCp6h3GNKCDq4ULaeGAKtSoYVEsHdzlBIs32aU0UkIxHIg/s400/Italy+foreign+population.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5609454295555650082" /></a><br /><br />During this time the labour force grew by about a million:<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjOUduJVfMwgo5mXboz_1_3d6ClNH1DBSNvDyFdmogBMfEuf0FJ11-qpW7AOAkQnbzA8WmmczwKWupUqAAZvxzglAEetq4k0scWKwcqX634yDebBSlrIOEzg-TzpxAved2HIeP2Ag/s1600/Italy+Labour+Force.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 238px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjOUduJVfMwgo5mXboz_1_3d6ClNH1DBSNvDyFdmogBMfEuf0FJ11-qpW7AOAkQnbzA8WmmczwKWupUqAAZvxzglAEetq4k0scWKwcqX634yDebBSlrIOEzg-TzpxAved2HIeP2Ag/s400/Italy+Labour+Force.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5609455378487596418" /></a><br />while employment was up by around 1.5 million.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEilxO4mYco9TCpwp7fTuE8Qh8H253vShdNPe8KLiQuc1vKC-5qL15zJHN1pB2oSGthy9S734iotJT0tK3MShnE6OfTP0hay0HiUPCwvtt_ftWdbKfYXN_SF-2tnsv7EI2Zo_to8xQ/s1600/Italy+Employed+Population.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 229px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEilxO4mYco9TCpwp7fTuE8Qh8H253vShdNPe8KLiQuc1vKC-5qL15zJHN1pB2oSGthy9S734iotJT0tK3MShnE6OfTP0hay0HiUPCwvtt_ftWdbKfYXN_SF-2tnsv7EI2Zo_to8xQ/s400/Italy+Employed+Population.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5609455924390402498" /></a><br /><br />In fact, since Italy left recession the number of those employed has hardly risen, while the percentage of those who are formally unemployed has remained near its crisis highpoint, which has been good for productivity, but not for consumer consumption, the ideal combination would be to see output and employment growing at a healthy pace, with output growing faster than employment. At the present time employment is hardly growing, and the rate of increase in output is slowing notably. That is to say we do not have "lift off".<br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj7JPAOKMEZsPLWK0zGcNTaJw52xG_1aWTU8TRt2VRJeb8Kkf6oL12rQk_7Iw_5qkhdsSQAyVPpokqqkEzy3aRhyphenhyphenczjW9GyQeYuPGr7ZVrN_TkzGaPswK15xLvPBSBLdBEDIFaHjw/s1600/Italy+Unemployment+Rate.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 249px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj7JPAOKMEZsPLWK0zGcNTaJw52xG_1aWTU8TRt2VRJeb8Kkf6oL12rQk_7Iw_5qkhdsSQAyVPpokqqkEzy3aRhyphenhyphenczjW9GyQeYuPGr7ZVrN_TkzGaPswK15xLvPBSBLdBEDIFaHjw/s400/Italy+Unemployment+Rate.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5609456360620486418" /></a><br /><br />Naturally, this lack of competitiveness is to be seen in Italy's deteriorating external position, and the drag on growth which this causes is seen clearly in this current account deficit and GDP growth comparison.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgN8aFOs78EiGFuRiJqmzjDxqkjMfsqwAwm7pV6nUVM05FPcC89uWss08EJ-Wlr2HvaoLf8OX05HlnRwpnEBKrGxmA3fJic_vDE61NetaLV-61mZSoA3kp3rqoYm94kik8vJfzA0w/s1600/Italy+GDP+%2526+CA+Compared.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 229px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgN8aFOs78EiGFuRiJqmzjDxqkjMfsqwAwm7pV6nUVM05FPcC89uWss08EJ-Wlr2HvaoLf8OX05HlnRwpnEBKrGxmA3fJic_vDE61NetaLV-61mZSoA3kp3rqoYm94kik8vJfzA0w/s400/Italy+GDP+%2526+CA+Compared.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5609531843736939458" /></a><br /><br /><br />Exports have been growing rapidly since the middle of last year, but imports have been growing even more rapidly, and hence the goods trade deficit has widened considerably.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg7R8UlnQTTkUB4CSo3VNx3nD0uhBDCcF_KtLbvjGNqxFMqN-BqtZ_n2CQPmJ3PVLBORSsBAFe2TYUGfczuiZqxMRZqs7GOV6XdsuyJ6lrxFL6lrj0v9Q8V6Ej4vnZlOJ4wZ0RVKw/s1600/Italy+Trade+Deficit.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 220px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg7R8UlnQTTkUB4CSo3VNx3nD0uhBDCcF_KtLbvjGNqxFMqN-BqtZ_n2CQPmJ3PVLBORSsBAFe2TYUGfczuiZqxMRZqs7GOV6XdsuyJ6lrxFL6lrj0v9Q8V6Ej4vnZlOJ4wZ0RVKw/s400/Italy+Trade+Deficit.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5609535188499519618" /></a><br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj2W49XbmIMLO_P0grsbNZMcZ-3e5wmtWEMtRjCUuKPg8Bxm14YlyiHsY4J6U7QD5_NdnAL4RxuPc3xmEt1QyB6Lv9myQlN-Tbq8E9sa1mFRPGgrxhihz8hItB3zUNWHCCQTEb3JQ/s1600/Italy+Exports+%2526+Imports+Y-o-Y.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 221px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj2W49XbmIMLO_P0grsbNZMcZ-3e5wmtWEMtRjCUuKPg8Bxm14YlyiHsY4J6U7QD5_NdnAL4RxuPc3xmEt1QyB6Lv9myQlN-Tbq8E9sa1mFRPGgrxhihz8hItB3zUNWHCCQTEb3JQ/s400/Italy+Exports+%2526+Imports+Y-o-Y.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5609534985197212898" /></a><br /><br /><b>Growing Your Way Out Of Debt?</b><br /><br />Aside from the impact on Italian living standards and welfare services, the big issue which arises from Italy's low and declining long term growth outlook is what this is likely to do for Italian plans to reduce the burden of its outstanding government debt. Is, for example, lower than expected growth likely to jeopardise Italy’s achievement of its deficit target for 2011? Well, if there was no increase in spending to compensate for the economic slowdown (and remember, Prime Minister Berlusconi's party just did very badly in regional and local elections) then the knock-on effect on the deficit would probably be small and probably not a large enough change to seriously call into question the Italian government's commitment to its fiscal policy targets given that the 4.6% deficit achieved in 2010 was 40bps below target and that the Government is aiming for a 2.7% deficit by 2012.<br /><br />But Italy's problem has not been its high deficit level during the crisis, it is the high debt level the Italian government has accumulated over the years, and the continuing under-performance in growth terms means the government may well struggle to turn the situation round, and that some sort of restructuring (soft or hard) at some point may well be needed. Let's take a look at why.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjFPBo30yW1PVrh4fN2BNTc6ixehsJUBplvcAYyCB00QvGpKQ7Au1S9Hln2PFN0-XFAnkfk4p2LWXecaakk8HPzjMkIdV11o3UP1dYxk2SMLcHxiLiTiBZfLwXBV3DeYozNp7IFYw/s1600/Italy+Government+Debt.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 227px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjFPBo30yW1PVrh4fN2BNTc6ixehsJUBplvcAYyCB00QvGpKQ7Au1S9Hln2PFN0-XFAnkfk4p2LWXecaakk8HPzjMkIdV11o3UP1dYxk2SMLcHxiLiTiBZfLwXBV3DeYozNp7IFYw/s400/Italy+Government+Debt.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5609460635547672914" /></a><br /><br />According to OECD data, while Italy ran cyclically adjusted primary deficits (that is deficits before including interest payments) every year between 1970 and 1991, the country has run cyclically adjusted primary surplus every year since 1992 - even during the depths of the recent crisis. Thus Italy’s cyclically adjusted primary balance (as a % of GDP) has been in better shape than the balance of many of the largest developed economies. Notwithstanding this, the weight of debt as a % of GDP has continued to rise. So, while Eurostat recently confirmed that the Italian 2010 public deficit was 4.6% of GDP, and 40 basis points below the Government target,the debt to GDP ratio was revised up to 119% (in this case higher than the Government’s target number). What makes the difference is the impact of history and the weight of the accumulated debt, since interest needs to be paid on the debt.<br /><br /><b>Ambitious Targets Which Will Be Nearly Impossible To Achieve</b><br /><br />Now Italy has set itself the objective of reducing the overall deficit below 3% of GDP by 2012. Indeed, the government’s 2011 Economics and Finance Document (EFD) sets itself extremely ambitious targets for fiscal policy. The objective is to achieve a broadly balanced budget by 2014 through the achievement of a deficit/GDP ratio of 3.9% in 2012, 2.7% in 2013, 1.5% in 2013 and a 0.2% in 2014 and (as the document says) “so on systematically increasing the primary surplus to continue on the path to reduce the public debt”. The aim is to maintain the fiscal balance within a range which is compatible with reducing the debt. But just how realistic is this objective?<br /><br />Well, to make a comparison, back in March, ECOFIN proposed quite far-reaching changes to the current Stability and Growth Pact (SGP). In particular the Finance Ministers proposals included the incorporation of a principle of extra fiscal effort for heavily indebted countries – a principle which has become widely known as the "debt-brake" condition. According to the new proposal excess debt, i.e. public debt above 60% of GDP, should be reduced by 1/20th per annum. This new debt-brake condition has important implications for heavily indebted countries who have so far escaped the full force of market attention, such as Belgium and Italy, since these two have to deal with debt to GDP ratios hovering around 100% and 120% respectively. What is surprising about the fiscal path proposed by the Italian government in its EFD is that it appears even tougher than that implied by the new EU debt-brake condition.<br /><br />Of course, assuming Italy meets its fiscal deficit objectives - which naturally imply no counter-cyclical stabiliser deficits during recessions (is this really realistic??) - the key variable to watch for the debt/GDP ratio is nominal GDP. Now Italy managed to achieve nominal GDP growth of around 4% a year in the decade before the crisis, and a rough and ready calculation suggests that with nominal GDP growth of around 4% debt to GDP would be down under 100% following the Econfin criteria, and under 95% following the Italian government's own EFT.<br /><br /><b>Catch Me (Out) If You Can</b><br /><br />But is a 4% growth in nominal GDP realistic for the rest of this decade? It is important to remember that the composition of the earlier 4% average annual growth, since only around 1% of it came from real GDP growth, while 3% came from inflation. And, of course, during this time, as we have seen, Italy lost considerable competitiveness with Germany. So what may help with one thing (debt to GDP) may be positively harmful to another (international competitiveness, the current account defecit). As Goldman Sachs economist Kevin Daly put it in a recent report:<br /><br /><blockquote>"For countries attempting to address these twin imbalances within a currency union, there is a ‘Catch 22’ situation: competitiveness can only be regained via real exchange rate adjustment (i.e., by running lower inflation than the Euro-zone average). However, in order to boost public sector finances, economies need stronger nominal GDP growth and, thus, relatively low inflation (or deflation) has the effect of exacerbating the public-sector deficit problem. In other words, it is difficult to address one imbalance without exacerbating the other, and vice versa".</blockquote><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi7Ko98bOX3-UW050C8kpIGUsqiVM1zP3YhhIEVDWO8x0MB9izjFl02AMRRImvc2pWpDWdb-lUN2kYIHNoMpR_6-901l3FPtIK13EPyN9R8OZQA1Ug_QE4zIhx2hjgORz8mdELjzg/s1600/Italy+%2526+EA17+CPI+compared.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 219px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi7Ko98bOX3-UW050C8kpIGUsqiVM1zP3YhhIEVDWO8x0MB9izjFl02AMRRImvc2pWpDWdb-lUN2kYIHNoMpR_6-901l3FPtIK13EPyN9R8OZQA1Ug_QE4zIhx2hjgORz8mdELjzg/s400/Italy+%2526+EA17+CPI+compared.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5609517050689376322" /></a><br /><br />If we simply take this years outlook as an example. Italy, as we have seen, is unlikely to achieve more than 1% real GDP growth (and this a year of strong global expansion), but the country might just get nominal GDP growth of 4%, since inflation is currently running near to 3%. At the same time Germany may have GDP growth nearer 4%, and inflation around 1% lower than Italy. These kind of inflation differentials just don't make sense, when you consider that it is Germany that is booming, and Italy that is near to falling back into recession. Such differences are symptoms of deep economic rigidities in Italy.<br /><br />So what if Italy were to have 1% inflation, and 3% real GDP growth? Well, just how plausible is this? Germany, as we have seen, has only been able to get 1.3% annual growth in productivity over the last decade, and it is hard to see Italy doing better, no matter how deep the structural reforms introduced. Indeed, Italy's long term trend growth has been slipping steadily over the last half century, at the rate of about 1% a decade, <a href="http://italyeconomicinfo.blogspot.com/2008/07/italys-economy-on-ropes-again.html">according to the Italian economist Francesco Daveri</a>:<br /><br /><blockquote>"Italy’s per-capita GDP growth was 5.4% in the 1950s, 5.1% in the 1960s, 3.1% in the 1970s, 2.2% in the 1980s and 1.4% in the 1990s. A rough-and-ready extrapolation of this decade-long continued slowdown would lead to expect no more than 0.5% in the 2000s."</blockquote>Since he wrote this in 2006, and growth over the decade was something like an average of 0.6% I would say that his expectation wasn't a bad guess. What puzzles me at all the people who now "guess" that Italy will be able to put in enough a much higher growth rate over the next decade.<br /><br /><b>All Together Now: "I Believe In Structural Reforms"</b><br /><br /> The IMF are expecting real growth of about 1.3% between 2012 and 2015, and the EU forecasts are not substantially different. As average growth rates this seem very optimistic to me, especially given the recent performance.<br /><br />All efforts seem to be directed towards impelling structural reforms, and this in itself is worrying, since what we seem to have is something more akin to blind faith than to sound empirical economic analysis. The most recent IMF Article IV Report concludes that: “only a bold and comprehensive structural reform program will unleash Italy’s growth potential”. But what is the likelihood of such a bold and comprehensive programme being introduced, and anyway, how much do we really know about Italy's real growth potential at this late day in its demographic history? While echoing the "structural reforms" mantra, <a href="http://www.oecd.org/document/8/0,3746,en_21571361_44315115_47725832_1_1_1_1,00.html">the OECD is rather more cautious</a>:<br /><br /><blockquote>Italy’s economy has passed the deep recession triggered by the global crisis and seems set for a gradual recovery. The strength of this recovery is uncertain: it would be wise to plan for no more than the rather sluggish growth seen in the decade prior to the crisis.</blockquote><br /><br />The problem is, like many on Europe's periphery, after a decade of Euro membership the Italian economy is seriously distorted, and badly in need of devaluation, but of course, as elsewhere there is no currency left to devalue, hence some sort of debt restructuring to reduce the burden of interest payments may be the only alternative while we await the jury's verdict as to whether all these structural reforms work or not.<br /><br />Many, of course, will say that Italy is a lot richer than it seems, since so much economic activity takes places in the informal sector. But this is entirely beside the point, since the informal sector by definition does not pay taxes, and I will believe a promise to reduce the importance of the informal sector when I see the results. In the meantime Italy is, at best, a country which is much richer than it seems where government finances are in danger of spinning off into an unsustainable debt spiral.<br /><br />As Standard & Poor's put it<a href="http://www.reuters.com/article/2011/05/21/italy-sp-idUSLDE74K08M20110521?type=bondsNews"> in the statement accompanying their decision last week</a> to put Italian Sovereign Debt on rating watch negative: "In our view Italy's current growth prospects are weak, and the political commitment for productivity-enhancing reforms appears to be faltering. Potential political gridlock could contribute to fiscal slippage. As a result, we believe Italy's prospects for reducing its general government debt have diminished."Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-3949752.post-54734630883186753622010-02-14T14:35:00.000+01:002010-02-14T14:37:24.229+01:00Just What Is The Real Level Of Government Debt In Europe?<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhjevesc9_w9tsK4IVU4PS_n7MppnqGY63z53ef_3Z2NSKTR9B2hO_Zga2A9w4z8MsSNx4K5f1Ks6oy6cYGmh0kMFwa6o_ZiTF42E_peD32QgU5PuqgOrgeoo_8PQW6MJ04ppt9_Q/s1600-h/Botin.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 267px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhjevesc9_w9tsK4IVU4PS_n7MppnqGY63z53ef_3Z2NSKTR9B2hO_Zga2A9w4z8MsSNx4K5f1Ks6oy6cYGmh0kMFwa6o_ZiTF42E_peD32QgU5PuqgOrgeoo_8PQW6MJ04ppt9_Q/s400/Botin.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5438085487868523106" /></a><br /><br />“If you don’t fully understand an instrument, don’t buy it.”<br /><br />To the above advice from Emilio Botín, Executive Chairman of Spain’s Grupo Santander, I would simply add one small rider: Don’t sell it either, especially if you are a national government trying to structure your country’s debt.<br /><br />In <a href="http://www.nytimes.com/2010/02/14/business/global/14debt.html?pagewanted=1">a fascinating article in today's New York Times</a>, journalists Louise Story, Landon Thomas and Nelson Schwartz begin to recount the mirky story of just how the major US investment banks have been able to earn considerable sums of money effectively helping European governments to disguise their growing mountain of public debt.<br /><blockquote>Wall Street tactics akin to the ones that fostered subprime mortgages in America have worsened the financial crisis shaking Greece and undermining the euro by enabling European governments to hide their mounting debts. <br /><br />As worries over Greece rattle world markets, records and interviews show that with Wall Street’s help, the nation engaged in a decade-long effort to skirt European debt limits. One deal created by Goldman Sachs helped obscure billions in debt from the budget overseers in Brussels. <br /><br />Even as the crisis was nearing the flashpoint, banks were searching for ways to help Greece forestall the day of reckoning. In early November — three months before Athens became the epicenter of global financial anxiety — a team from Goldman Sachs arrived in the ancient city with a very modern proposition for a government struggling to pay its bills, according to two people who were briefed on the meeting. The bankers, led by Goldman’s president, Gary D. Cohn, held out a financing instrument that would have pushed debt from Greece’s health care system far into the future, much as when strapped homeowners take out second mortgages to pay off their credit cards.</blockquote><br /><br />In fact, concerns about what it is exactly Goldman Sachs have been up to in Greece are not new, and the Financial Times have been pusuing this story for some time, in particular in connection with the investment bank's <a href="http://www.ft.com/cms/s/0/53bbbd40-0c42-11df-8b81-00144feabdc0.html">ill fated attempt to persuade the Chinese to buy Greek government debt</a> (and <a href="http://ftalphaville.ft.com/blog/2010/02/09/145201/goldmans-trojan-greek-currency-swap/">here</a>, and <a href="http://www.zerohedge.com/article/ever-increasing-parallels-between-aig-and-greece-and-cds-puppetmaster-behind-it-all">here</a>). Nor is the fact that the Greek government resorted to sophistocated financial instruments to cover its tracks exactly breaking news, since I (among others) have been writing about this topic since the middle of January - <a href="http://greekeconomy.blogspot.com/2010/01/does-anyone-really-know-size-of-greek.html">Does Anyone Really Know The Size Of The Greek 2009 Deficit?</a> - following the arrival in my inbox of a leaked copy of the report the Greek Finance Minister sent to the EU Commission detailing the issues. <br /><br />What is new in today's report from the NYT team is the extent to which they identify the problem as a much more general one, involving more banks and more countries, since "Instruments developed by Goldman Sachs, JPMorgan Chase and a wide range of other banks enabled politicians to mask additional borrowing in Greece, Italy and possibly elsewhere". I very strongly suggest that our NYT stalwarts take a long hard look at what has been going on in Spain, and especially at the Autonomous Community level.<br /><br />So the question naturally arises, just how much in debt are our governments, really? As the NYT team point out, Eurostat has long been grappling with this matter, and as far back as 2002 they found themselves forced to change their accounting rules, in order to try to enforce the disclosure of many off-balance sheet entities that had previously escaped detection by the EU, since up to that point the transactions involved had been classified as asset "sales", often of public buildings and the like. Following advice paid for from the best of investment banks many European governments simply responded to the rule change by reformulating their suspect deals as loans rather than outright sales. As we say in Spain "hecha la ley, hecha la trampa" (or in English, when you close one loophole you open another). According to the NYT authors:<br /><br />"As recently as 2008, Eurostat.... reported that “in a number of instances, the observed securitization operations seem to have been purportedly designed to achieve a given accounting result, irrespective of the economic merit of the operation.”"<br /><br />So just what is all the fuss about. Well, in plain and simple terms it is about an accounting item known as "receivables". Now, <a href="http://en.wikipedia.org/wiki/Accounts_receivable">according to the Wikipedia entry</a>:<br /><br /><blockquote>"Accounts receivable (A/R) is one of a series of accounting transactions dealing with the billing of a customers for goods and services received by the customers. In most business entities this is typically done by generating an invoice and mailing or electronically delivering it to the customer, who in turn must pay it within an established timeframe called credit or payment terms."</blockquote><br /><br />However, as <a href="http://en.wikipedia.org/wiki/Factoring_(finance)">we can learn from another Wikpedia entry</a>, often the use of "accounts receivable" constitutes a form of factoring, and this is where the problems Eurostat are concerned about actually start:<br /><br /><blockquote>Factoring is a financial transaction whereby a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount in exchange for immediate money with which to finance continued business. Factoring differs from a bank loan in three main ways. First, the emphasis is on the value of the receivables (essentially a financial asset), not the firm’s credit worthiness. Secondly, factoring is not a loan – it is the purchase of a financial asset (the receivable). Finally, a bank loan involves two parties whereas factoring involves three.</blockquote><br /><br />But how does all this work in practice? Well, the World Wide Web is a wonderful thing, since you have so much information near to hand, at just the twitch of a fingertip. <a href="http://www.john-laing.co.uk/pfi_ppp/948.htm">Here is a useful description of what are known as PPI/PFI schemes</a>, from UK building contractor John Laing:<br /><blockquote>A Public Private Partnership (PPP) is an umbrella term for Government schemes involving the private business sector in public sector projects. <br /><br />The Private Finance Initiative (PFI) is a form of PPP developed by the Government in which the public and private sectors join to design, build or refurbish, finance and operate (DBFO) new or improved facilities and services to the general public. Under the most common form of PFI, a private sector provider like John Laing will, <strong>through a Special Purpose Company (SPC)</strong>, hold a DBFO contract for facilities such as hospitals, schools, and roads according to specifications provided by public sector departments. Over a typical period of 25-30 years, <strong>the private sector provider is paid an agreed monthly (or unitary) fee by the relevant public body</strong> (such as a Local Council or a Health Trust) for the use of the asset(s), which at that time is owned by the PFI provider. This and other income enables the repayment of the senior debt over the concession length. (Senior debt is the major source of funding, typically 90% of the required capital, provided by banks or bond finance). Asset ownership usually returns to the public body at the end of the concession. In this manner, <strong>improvements to public services can be made without upfront public sector funds</strong>; and while under contract, the risks associated with such huge capital commitments are shared between parties, allocated appropriately to those best able to manage each one.</blockquote><br /><br />And for those still in the dark, <a href="http://en.wikipedia.org/wiki/Private_finance_initiative">Wikipedia just one more time comes to the rescue</a>:<br /><br /><blockquote>The private finance initiative (PFI) is a method to provide financial support for "public-private partnerships" (PPPs) between the public and private sectors. Developed initially by the Australian and United Kingdom governments, PFI has now also been adopted (under various guises) in Canada, the Czech Republic, Finland, France, India, Ireland, Israel, Japan, Malaysia, the Netherlands, Norway, Portugal, Singapore, and the United States (amongst others) as part of a wider program for privatization and deregulation driven by corporations, national governments, and international bodies such as the World Trade Organization, International Monetary Fund, and World Bank.<br /><br />PFI contracts are currently off-balance-sheet, meaning that they do not show up as part of the national debt as measured by government statistics such as the Public Sector Borrowing Requirement (PSBR). The technical reason for this is that the government authority taking out the PFI contract pays a single charge (the 'Unitary Charge') for both the initial capital spend and the on-going maintenance and operation costs. This means that the entire contract is classed as revenue spending rather than capital spending. As a result neither the capital spend nor the long-term revenue obligation appears on the government's balance sheet. Were the total PFI liability to be shown on the UK balance sheet it would greatly increase the UK national debt.</blockquote><br /><br />And here are two more examples of what is involved which were brought to light by a quick Google. First of all, the case of Italian health payments. Now according to analysts Patrizio Messina and Alessia Denaro, <a href="http://www.orrick.com/fileupload/753.pdf">in this report I found online from Financial Consultants Orrick</a>:<br /><br /><blockquote>In the last years many structured finance transactions (either securitisation transactions or asset finance transactions) have been structured in relation to the so called healthcare receivables.The reasons are several. On one side, the providers of healthcare goods and services usually are not paid in time by the relevant healthcare authorities and therefore, in order to gain liquidity, usually assign their receivables toward the healthcare authorities. On the other side, due to the recent legislation that provides for very high interest rates on late payments, the debtors as well as banks and other investors have had the same and opposite interest on carrying out different kind of transactions. In this brief article we will analyse, after a quick description of the Italian healthcare system, some of the different structures that have been used in relation to transactions concerning healthcare receivables and, in particular, we will focus on transactions concerning the so called “raw receivables”, which are lately increasing in the Italian market practice, by analysing the legal means through which it is possible to ascertain/recover such receivables.</blockquote><br /><br />This system thus has two advantages (apart from the fact that it effectively hides debt). In the first place the healthcare providers gain liquidity in order to continue to run hospitals, pay doctors, etc, while those who effectively intermediate the transaction earn very high interest rates for their efforts, interest payments which have to be deducted from next years health care provision, and so on. <br /> <br />As the Orrick report points out, Italy’s national healthcare service (servizio sanitarionazionale, “nhs”) is regulated by the legislative decree of December 30, 1992, no. 502 (“decree 502/92”).The reform introduced by decree 502/92, as amended from time to time, provides for a three-tier system for the healthcare service, as outlined below: State level The central government provides a national legislation limited to very general features of the NHS and decides the funds to be allocated to the single regions according to specific criteria (density of population, etc.) for the NHS. <br /><br />As the Orrick analysts note: "the Healthcare Authorities usually pay the relevant Providers with a certain delay".<br /><blockquote>Usually, when healthcare funds are allocated, in the national provisional budget, the central government underestimates the amount of healthcare expenditure. Since the central government does not provide regions with enough funds, regions are not able to provide enough funds to Healthcare Authorities, and payments to the Providers are delayed. Since the Providers need liquidity, they usually assign their receivables toward the Healthcare Authorities. To deal with all the above issues, Italian market practice has been developing an alternative system of financing through securitisation and asset finance transactions of Healthcare Receivables.</blockquote><br /><br />As the analysts finally conclude:<br /><br /><blockquote>Despite of the risks concerning the judicial proceedings, Italian market players are still very interested on carrying on securitisation transaction on this kind of asset, <strong>principally because Legislative Decree no. 231/02 provides for very high interest rates on late payments</strong> (equal to the interest rate applied by ECB plus 7%) - my emphasis</blockquote><br /><br />Another technique Eurostat have identified as a means of concealing debt relates to the recording of military equipment expenditure, <a href="http://www.defense-aerospace.com/article-view/feature/67285/bureaucrat's-delight:-eu-rules-on-military-leases.html">as described in this report I found dating from 2006</a>. At the time Eurostat were worried about the growing provision of military equipment under leasing agreements. Basically they decided that such provision was debt accumulable.<br /><blockquote>Eurostat has decided that leases of military equipment organised by the private sector should be considered as financial leases, and not as operating leases. This supposes recording an acquisition of equipment by the government and the incurrence of a government liability to the lessor. Thus there is an impact on government deficit and debt at the time that the equipment is put at the disposal of the military authorities, and not at the time of payments on the lease. Those payments are then assimilated as debt servicing, with a part recorded as interest and the remainder as a financial transaction.</blockquote><br /><br />However, a loophole was found in the case of long term equipment purchases:<br /><br /><br /><blockquote><br />Military equipment contracts often involve the gradual delivery over many years of a number of the same or similar pieces of equipment, such as aircraft or armoured vehicles, or including significant service components, such as training. Moreover, in the case of complex systems, it is frequently the case that some completion tasks need to be performed for the equipment to be operational at full potential capacity. Some military programmes are based on the combination of several kinds of equipment that may be completed in different periods, so that the expenditure may be spread over several fiscal years before the system, globally considered, becomes fully operational. <br /><br />In cases of long-term contracts where deliveries of identical items are staged over a long period of time, or where payments cover the provision of both goods and services, government expenditure should be recorded at the time of the actual delivery of each independent part of the equipment, or of the provision of service. </blockquote><br /><br />Payment for such items are only to be classifed as debt at the time of registering the actual delivery, which may explain why, if my information is correct, the Greek military as of last December were still officially "testing" two submarines which had been provided by German contractors, since final delivery had still to be formally registered, and the debt accounted.<br /><br />A lot of information about the kind of things which were going on before the 2006 rule change can be found <a href="http://www.europlace.net/paris06/p9-charlotte_lavit_d_hautefort.pdf">in this online presentation from Europlace Financial Forum</a>. Here are some examples of private/public sector cooperation in Italy.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgQIfUQjLbPUFqsna09DJO6QedwXVsfs-c3ae2SAIY9WnfJb6x0yBH7CN6Il7t2kCdTMwwd1sQn32HzjSDTPd7Ykasg0XUK5Wr3lZlEL4DsrJyT1l-yMLq9IiAE0hNFFyLeZN-knw/s1600-h/Italy+receivables.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 300px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5438045860714137330" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgQIfUQjLbPUFqsna09DJO6QedwXVsfs-c3ae2SAIY9WnfJb6x0yBH7CN6Il7t2kCdTMwwd1sQn32HzjSDTPd7Ykasg0XUK5Wr3lZlEL4DsrJyT1l-yMLq9IiAE0hNFFyLeZN-knw/s400/Italy+receivables.png" /></a><br /> <br />And here's a chart showing a list of advantages and possible applications:<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh9LK4dHqIkTtwRfHQVs_BdNC2VkECzeH6PXtm-zn58qOpuY4rT1vlf56phWBd7AaCXq-Ug36fRMzL5PZzkAoUwDdI_slMoyALHgpbAbAUFkfFeS9z0C-Y_B_9LwEeb7Y00KtryvQ/s1600-h/Receivable+projects.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 298px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh9LK4dHqIkTtwRfHQVs_BdNC2VkECzeH6PXtm-zn58qOpuY4rT1vlf56phWBd7AaCXq-Ug36fRMzL5PZzkAoUwDdI_slMoyALHgpbAbAUFkfFeS9z0C-Y_B_9LwEeb7Y00KtryvQ/s400/Receivable+projects.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5438046932968852178" /></a><br /><br />Now, at the end of the day, you may ask "what is wrong with all of this"? Well quite simply, like Residential Mortgage Backed Securities these are instruments that work while they work, and cause a lot of additional headaches when they don't. I can think of three reasons why debt aquired in this way in the past may now be problematic.<br /><br />a) they assume a certain level of headline GDP growth to furnish revenue growth to the public agencies committed to making the payments. Following the crisis these previous levels of assumed growth are now unlikely to be realised.<br />b) they assume growing workforces and working age populations, but both these, as we know, are now likely to start declining in many European countries.<br />c) they assume unchanging dependency ratios between active and dependent populations, but these assumptions, as we also already know, are no longer valid, as our population pyramids steadily invert.<br /><br />Given all this, a very real danger exists that what were previously considered as obscure securitisation instruments, so obscure that few politicians really understood their implications, and few citizens actually knew of their existence, can suddenly find themselves converted into little better than a glorified Ponzi scheme.<br /><br />And if you want one very concrete example of how unsustainable debt accumulation can lead to problems, you could try reading <a href="http://www.laverdad.es/murcia/v/20100214/region/indigencia-municipal-20100214.html">this report in the Spanish newspaper La Verdad</a> (Spanish, but Google translate if you are interested), where they recount the problems being faced by many Spanish local authorities who are now running out of money, in this case it the village of San Javier they have until the 24 February to pay a debt of 350,000 euros, or the electricity will simply be cut off! The article also details how many other municipalities are having increasing difficulty in paying their employees. And this is just in one region (Murcia), but the problem is much more general, as Spain's heavily overindebted local authorities and autonomous communities steadily grind to a halt.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-3949752.post-43380646710080628782010-02-12T12:56:00.010+01:002010-02-12T17:52:02.729+01:00The Italian Economy Contracts Again in Q4 2009Well, it isn't only <a href="http://fistfulofeuros.net/afoe/economics-and-demography/is-there-a-double-dip-risk-in-germany/">my German economy Q4 call</a>, or <a href="http://japanjapan.blogspot.com/2009/12/double-dip-alert-in-japan.html">my Japanese economy one</a> which look OK right now, <a href="http://italyeconomicinfo.blogspot.com/2010/01/italian-lion-sleeps-yet-awhile.html">this Italian one also now seems very much to the point</a>.<br /><br />In fact, as I suspected it might, <a href="http://www.google.com/hostednews/afp/article/ALeqM5iLLuaH3pNMRiOVLjh4kxTp26sJEg">the Italian economy went back into contraction mode in the last three months of 2009</a>.<br /><br /><blockquote>Italy's economy shrank by 0.2 percent in the fourth quarter of 2009, inverting the growth it had experienced in the third quarter, according to national statistics agency Istat in a preliminary forecast. Italian gross domestic product (GDP) shrank by 0.2 percent compared to the third quarter when adjusted for seasonal variations.</blockquote><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhk0duIWe7_uAtjqtFYB6FC0VUyPtfa4qZnk9Lrm8pldX4jKSAnrqPkX0KH8moMb9coFSxAAxUsGtAyeLcDH-VXuY0qZ15HGiHKLqSIEYfCrCSTTEL2VoIcno58YlTaB87U1iLyUA/s1600-h/GDP+Three.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 230px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5437325300043659586" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhk0duIWe7_uAtjqtFYB6FC0VUyPtfa4qZnk9Lrm8pldX4jKSAnrqPkX0KH8moMb9coFSxAAxUsGtAyeLcDH-VXuY0qZ15HGiHKLqSIEYfCrCSTTEL2VoIcno58YlTaB87U1iLyUA/s400/GDP+Three.png" /></a><br /><br /><blockquote>Italy's GDP shrank by 4.9 percent in the 2009, a result which was slightly worse than than the 4.8 percent contraction the Italian government had predicted. The fourth quarter figure was worse than had been expected by economists who had forecast a 0.1 percent growth, according to a consensus polled by Dow Jones Newswires. Istat blamed the decrease on a fall in the value added by Italian industry. In January, the Italian government revised its economic growth forecast for 2010 upward - from 0.7 percent to 1.1 percent.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjYU2cornpOoA8QTX41AiZtEOZ8i1WDMMm4ZgifDL4TY1V6NI-icswHogD9gFgS-bMwZTlDJ3LEm65yfCnzfFuFm96Tm7un5_QVxxd6Qa3JN-CrwhBFYQra9iamd8seOYkYTHw3pw/s1600-h/GDP+two.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 230px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5437325156751178370" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjYU2cornpOoA8QTX41AiZtEOZ8i1WDMMm4ZgifDL4TY1V6NI-icswHogD9gFgS-bMwZTlDJ3LEm65yfCnzfFuFm96Tm7un5_QVxxd6Qa3JN-CrwhBFYQra9iamd8seOYkYTHw3pw/s400/GDP+two.png" /></a></blockquote><br /><br /><br />Perhaps the best way of putting the seriousness of Italy's situation in some kind of perspective is to say that GDP levels are still below those of early 2003. My opinion is that even in the best of cases Italian trend GDP growth is now below 0.5% per annum, and indeed it may well be approaching zero.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhu0KTJXa8M0EmdScLI9UnJ2929KN_bONBJSBBo1SbtDTDu-ZzLZ1y9yOkOVcRCdErht0EdG4s8WZg2DPJi05OEgjxwNoxOdI0KQ5X9phdw0vyGbzacdYjbIg3e0KIZcLdcrTh1lQ/s1600-h/Italy+GDP+one.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 235px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhu0KTJXa8M0EmdScLI9UnJ2929KN_bONBJSBBo1SbtDTDu-ZzLZ1y9yOkOVcRCdErht0EdG4s8WZg2DPJi05OEgjxwNoxOdI0KQ5X9phdw0vyGbzacdYjbIg3e0KIZcLdcrTh1lQ/s400/Italy+GDP+one.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5437399519345920530" /></a>Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-3949752.post-19913761075461589452010-01-17T06:33:00.005+01:002010-01-17T20:32:33.383+01:00The Italian Lion Sleeps Tonight, And Yet Awhile..........<blockquote>“If we look at public-sector debt and interest payments, Greece isn’t doing particularly worse than Italy,” Peter Westaway,Chief Economist Europe at Nomura International</blockquote>To everyone's relief, Italy's economy returned to growth in the third quarter of 2009, following five consecutive quarters of contraction. But that doesn't make the future look or feel any more secure than the recent past, and while an immediate return to a sharp recession isn't likely, it still isn't clear whether the Q3 performance was repeated over the last three months of last year, or whether output remained more or less flat. This does seem to be a more or less a touch and go call, and while the final result will hardly be a shocker one way or the other, my feeling is that we are looking at growth in the region of -0%. That is to say, slight contraction is marginally more likely than slight expansion. So Italy's economy is more or less dormant, but it's debt to GDP ratio is not, and is moving steadily upwards (see the last section of this post), so the lion sleeps tonight, and goes on sleeping, but what will happen tomorrow when she, or rather the financial markets, finally wake up, and discover seems evident, at least to me and Peter Westaway, that in the longer run Italy's sovereign debt problem is every bit a large as the Greek one, although given that most of the debt is in fact held by Italians, the threat to the good functioning of the eurosystem may well be proportionately less.<br /><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgC8ieqExdm-3rtBKgS9xu6hZxOdXglY2HTwe_Uv6V0aMP8KmnP04JvWsrmttIAu0r1UvHstRagKKcYPfiweQaWSxf2fxLtG229q3Xy5McTyTXKiCaqhW-4lEAIqovHrauui_d23Q/s1600-h/italy+long+term+GDP.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 196px" id="BLOGGER_PHOTO_ID_5427324377543946578" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgC8ieqExdm-3rtBKgS9xu6hZxOdXglY2HTwe_Uv6V0aMP8KmnP04JvWsrmttIAu0r1UvHstRagKKcYPfiweQaWSxf2fxLtG229q3Xy5McTyTXKiCaqhW-4lEAIqovHrauui_d23Q/s400/italy+long+term+GDP.png" /></a><br /><br /><strong>A "Weak" Recovery</strong><br /><br />If the most recent past is still clouded in uncertainty, what is a little less in doubt is the sort of rebound we might expect from the Italian economy, since any bounceback will surely be extremely muted to say the least. The Italian economy has been loosing steam for decades now, and only grew by something less than 0.5% per annum over the last - boom - decade. With the working age population declining and ageing, the outlook for the next decade is hardly improved. <br /><br />My best-guess estimate is that the Italian economy contracted by something like 4.8% in 2009 (just a little less than the 5% German contraction), following a 1% drop in output in 2008. Consenus opinion is mildly optimistic for the year to come, but expectations are modest with the Bank of Italy arguing that what is still the euro region’s third-biggest economy will experience a “weak recovery” this year and a 0.7 percent expansion in 2011. Of course, as with forecasting the weather, the further into the future you move, the greater the level of uncertainty which is attached to any growth estimate, and in current global conditions this is even more the case. The Italian central bank forecast compares with a November projection from the Organization for Economic Cooperation and Development of 1.1 percent growth this year and 1.5 percent in 2011, while the IMF projects 0.25% growth for 2010 and 0.75% for 2011, and the EU Commission currently project 0.7% for this year and 1.4% for 2011.</p>Certainly all parties project that internal consumption will remain weak, and what growth they are expecting should be driven by external demand, which, of course, is itself subject to considerable uncertainty as government stimulus after government stimulus is steadily withdrawn. Almost all EU economies are now looking to live from surplus demand in other countries, and like the British working classes in the nineteenth century they can't all surely hope to live from "taking-in each others washing".<br /><p>More than talking about growth, what we are really talking about is getting back to where we were, since if we look at the level of Italian GDP, it is clear that there has been a sharp drop in output since the start of 2008, and at current rates of growth it will be many years before we get back up to 2007 levels.</p><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiedBKwH65OxwraW-K_A_qMWJeXTYWIkWVAVRUW_vDsKt0-whLNbO6-8YRamspFh1PX85ypeBPa0pwm34YoTPJMKlUg-Ypn54N41km1AdjWgRo1DD4RR48paxw9atiOUGjY8_Thjw/s1600-h/Italy+GDP+one.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 235px" id="BLOGGER_PHOTO_ID_5427335236877152610" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiedBKwH65OxwraW-K_A_qMWJeXTYWIkWVAVRUW_vDsKt0-whLNbO6-8YRamspFh1PX85ypeBPa0pwm34YoTPJMKlUg-Ypn54N41km1AdjWgRo1DD4RR48paxw9atiOUGjY8_Thjw/s400/Italy+GDP+one.png" /></a><br /><br />Mario Draghi, Governor of the Bank of Italy suggested at the end of last year that it would take four years for the Italian economy to return to its 2007 size. If the recovery is slower than anticipated these four years could easily turn into five or six with fairly serious implications for the Italian sovereign debt dynamic. Indeed, there already appear to be more downside risks emerging than the above forecasts contemplated and <a href="http://uninews.unicredit.it/en/articles/page.php?id=11813">I'm inclined to agree with that doyen of Italian economy bank analysts - Unicredit's Marco Valli</a> - when he argues for a likely upper limit to growth this year at around 0.5%, with plenty of scope for it to come in even lower.<br /><br /><strong>Touch and Go In Q4 </strong><br /><br /></p><blockquote>" We doubt that the pace of growth seen in the third quarter will be maintained in the fourth one: given the weak momentum with which industrial production closed the third quarter (-5.3% monthly in September after +5.8% in August), a substantial deceleration in industrial activity and GDP is likely in the final quarter. However, given that manufacturing surveys keep pointing north, car registrations remain firm and there are increasing signs that services activity is starting to re-gain some traction, we have penciled in flat GDP for the fourth quarter"<br />Unicredit's Italy Economist, Marco Valli, 23 November 2009</blockquote> <br />In line with most analyst expectation expectations, the Italian economy expanded by 0.6% between the second and third quarters of 2009, an improvement which was largely driven by a 4.3% quarter on quarter (qoq) rise in industrial output. GDP also benefited from a rebound in exports (+2.5% qoq) and machinery/equipment investment (+4.2%), some growth in private consumption (+0.4%, on strong car registrations) and a moderately positive contribution from inventories (+0.1pp). The evident weakness was construction investment, which continued to fall sharply (-2.1%).<br /><br />Industrial production has been steadily losing momentum in the fourth quarter, and was up only 0.2% in November, on the back of a revised 0.7% increase in October. These rises follow a sharp 4.9% drop in September which means, assuming the upward December output rise is close to that indicated in the last PMI, industrial production in the last three months will be more or less flat in the final quarter when compared with the third, and could even be slightly down.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh1BkP-V77MDTriL2q5OMqqAILHZBxBNC9Rv8iOeG7W1VPWXParFerp8K8yscpZC_cXWhmqZC96FfxXaHY5QT0U6hxWPTv7z1Hns0wdV2ttBIxdbLgdnGRWHKcOh5jBP23WZvbkjg/s1600-h/Italy+IP.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 221px" id="BLOGGER_PHOTO_ID_5427377025280540002" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh1BkP-V77MDTriL2q5OMqqAILHZBxBNC9Rv8iOeG7W1VPWXParFerp8K8yscpZC_cXWhmqZC96FfxXaHY5QT0U6hxWPTv7z1Hns0wdV2ttBIxdbLgdnGRWHKcOh5jBP23WZvbkjg/s400/Italy+IP.png" /></a><br />On the other hand, Italian consumer activity - normally the weak spot in Italian GDP - does seem to have recovered rather during the quarter. Consumer confidence has imporved considerably of late.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhKl4KGikzAW0YxpUDulAe6F3kU7JPqr1Nu7DibEVbn-o7CbDiQQ3joai9Zov8Tup-ddxhCNXXOSUT_HnGzvqBvnd6v_yEJQF5_GQAfDw8c-L9WbDUryP3nLp2OZsFaoO2Q_nlnEg/s1600-h/Consumer+Confidence.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 219px" id="BLOGGER_PHOTO_ID_5427378354632152050" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhKl4KGikzAW0YxpUDulAe6F3kU7JPqr1Nu7DibEVbn-o7CbDiQQ3joai9Zov8Tup-ddxhCNXXOSUT_HnGzvqBvnd6v_yEJQF5_GQAfDw8c-L9WbDUryP3nLp2OZsFaoO2Q_nlnEg/s400/Consumer+Confidence.png" /></a><br /><br />And while retail sales have long since stopped their upward trend ...<br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhdsd3t37mt_t0NPeo5vawBAVSxEc173OV9-klINWoGkcv8UxfEvCn9eMJLzkClWRcYd1mCgApMzNRUYEI0lzwRwqCYeDIjjjLN0En0jy-tHUi-uH-5c0WOIaAh-I-eiWrP0rBzcQ/s1600-h/Italy+Retail+Index.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 218px" id="BLOGGER_PHOTO_ID_5427378761905308978" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhdsd3t37mt_t0NPeo5vawBAVSxEc173OV9-klINWoGkcv8UxfEvCn9eMJLzkClWRcYd1mCgApMzNRUYEI0lzwRwqCYeDIjjjLN0En0jy-tHUi-uH-5c0WOIaAh-I-eiWrP0rBzcQ/s400/Italy+Retail+Index.png" /></a><br /><br />the retail PMI showed growth in both November and December following 32 consecutive months of decline.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjPzCJdcSyIwmKgfkN0PoGjSP-kR6GqTXbT5PtH_V4Myo1-_fR_LKglbNJmeEEJ4GBFmcUOvgCNTKv59rbqFq5AMX8PbGGg42fCRlBvUIAVVNZvRWQwf1jRWtcjmQYVijH70dRshg/s1600-h/italy.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 207px" id="BLOGGER_PHOTO_ID_5427383025418974130" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjPzCJdcSyIwmKgfkN0PoGjSP-kR6GqTXbT5PtH_V4Myo1-_fR_LKglbNJmeEEJ4GBFmcUOvgCNTKv59rbqFq5AMX8PbGGg42fCRlBvUIAVVNZvRWQwf1jRWtcjmQYVijH70dRshg/s400/italy.png" /></a><br /><br />Also services activity has been stronger, with the services PMI registering growth during the fourth the quarter for the first time in many months.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhJJhfhaKLFhI-OpoZuxWhQHhUOrcg-iB4KjwnK5CecNrzobvbzJBsFCof8BPqq8p3i_uWW-Me95OX48dnlJVDiSHBQHOaO0raxRtZ2dZWHC4nwkL-tTQ5sjHW2HSXikgbNfmWFjQ/s1600-h/italy+services.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 212px" id="BLOGGER_PHOTO_ID_5427396602516626098" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhJJhfhaKLFhI-OpoZuxWhQHhUOrcg-iB4KjwnK5CecNrzobvbzJBsFCof8BPqq8p3i_uWW-Me95OX48dnlJVDiSHBQHOaO0raxRtZ2dZWHC4nwkL-tTQ5sjHW2HSXikgbNfmWFjQ/s400/italy+services.png" /></a><br /><br />In fact private consumption has been looking up in the last two quarters, and this trend may continue.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjOE1EPVfFXErRvcWKtj1Qf6flV715wHluQwKB0ExE48osg6zoAg-kV8HSw0eOW8t7NkaqIyeUyKWgiPgYh96Lvm0-93zku1Ku0mLyenhooz0uSv4SyQ5fM2ks2joxydyh5Sdk7Hw/s1600-h/italy+private+consumption+qoq.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 231px" id="BLOGGER_PHOTO_ID_5427400207985628210" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjOE1EPVfFXErRvcWKtj1Qf6flV715wHluQwKB0ExE48osg6zoAg-kV8HSw0eOW8t7NkaqIyeUyKWgiPgYh96Lvm0-93zku1Ku0mLyenhooz0uSv4SyQ5fM2ks2joxydyh5Sdk7Hw/s400/italy+private+consumption+qoq.png" /></a><br /><br />However, at some point there will be a deceleration in momentum, since consumption will undoubtedly be negatively affected by the expiration of the car scrapping premium. As Marco Valli puts it: "the extent of the correction in durable goods spending crucially depends on whether the government decides to quit the premium outright (which we regard as unlikely) or opts for a gradual phasing out of the incentive scheme (more likely)". It is worth bearing in mind, however, that even if the current premium scheme were to be fully confirmed for the whole of 2010, the effect on car registrations would be much more restrained than in 2009, due to the fact that most of the earlier pent-up demand has already been met.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjYm9lNOGo1VenamfvPrNpCMvxxB4Coa2lKfMu-uKJgfJNe5XW8RNh98Tweq4PiwkjlSbeIw38PF5QyRMRyMmhyphenhyphenynAdzhLou0vYsbrhnwpkqap-_6QuJgdaigfrMVu974oJ4Sjy9g/s1600-h/Italy+car+registrations.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 276px" id="BLOGGER_PHOTO_ID_5427406301231217922" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjYm9lNOGo1VenamfvPrNpCMvxxB4Coa2lKfMu-uKJgfJNe5XW8RNh98Tweq4PiwkjlSbeIw38PF5QyRMRyMmhyphenhyphenynAdzhLou0vYsbrhnwpkqap-_6QuJgdaigfrMVu974oJ4Sjy9g/s400/Italy+car+registrations.png" /></a><br /><br /><strong>Is Italy Export Dependent?</strong><br /><br />Even if this seems strange to many people, the Italian economy is, in fact, highly export-driven. In this sense Italy is heavily reliant upon the recovery of German demand, and it just thios demand which now seems to be faltering. In Q1 2009, German imports fell 5.4% over the previous quarter, after dropping in Q4 2008, driving Italy's economy further and further down.<br /><br />Exports amounted to some 28.8% of Italian GDP in 2008. In the third quarter of last year Italian exports grew by 2.5% on the quarter following a 2.5% drop in the previous one, while imports were only up 1.5% following a 2.5% drop in the second quarter. Thus the trade factor was positive for GDP growth. This situation seems set to change in the last quarter. Seasonally adjusted October exports were down, while imports fell less than exports, and if this trend is continued in November and December net trade will in fact be a drag on GDP. To my insufficiently well trained eyes it looks very much like the German car stimulus gave a big boost to Italian industry in August, and that this effect is now waning, even if the domestic Italian stimulus counterbalances to some extent.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjaCU81yMyA0YdgrcNGkOF04d8LyrkD7I99aHMWBMWr51zCHaNYiTQ92ys2MOHty_h_jXiPG3mfFM-DLQ8VFRt-oPBQaD4x4pGC3Vqq4mqy-yDAbU_iqzKZlehXUHbNs6wFRqBBiw/s1600-h/italy+exports.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 222px" id="BLOGGER_PHOTO_ID_5427402750912035634" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjaCU81yMyA0YdgrcNGkOF04d8LyrkD7I99aHMWBMWr51zCHaNYiTQ92ys2MOHty_h_jXiPG3mfFM-DLQ8VFRt-oPBQaD4x4pGC3Vqq4mqy-yDAbU_iqzKZlehXUHbNs6wFRqBBiw/s400/italy+exports.png" /></a><br /><br /><strong>Fixed Capital Investment Stimulated By Tax Incentives</strong><br /><br />Capital spending decisions look little better. Spending on machinery and equipment was up 4.2% quarter over quarter in Q3, but was still down 16.1% on the year, and the relatively strong recent performance is partly due to a tax incentive provided by the Italian government.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgfWU4G2fp683T6TCWa1Xnl_1d6vjHkhXwIjORY9dmyeJ5kzswfBrofXyUyvntlWRv_geZ-Ny8TWadWdYMoxZsASFS8Gr5zcygaP78VnVQsxh7IBWvXIKdYX9kC2RaTo008pyOBmQ/s1600-h/Italy+fixed+capital.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 230px" id="BLOGGER_PHOTO_ID_5427410095904692514" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgfWU4G2fp683T6TCWa1Xnl_1d6vjHkhXwIjORY9dmyeJ5kzswfBrofXyUyvntlWRv_geZ-Ny8TWadWdYMoxZsASFS8Gr5zcygaP78VnVQsxh7IBWvXIKdYX9kC2RaTo008pyOBmQ/s400/Italy+fixed+capital.png" /></a><br /><br />Again, Marco Valli points out that investment decisions are likely to remain conservative next year, since levels of corporate indebtedness are still high in an environment where profitability is notably weak. Moreover, extremely depressed capacity utilization rates will unavoidably put a ceiling on business investment. However, Valli suggests that firms will undoubtedly continue to take advantage of the tax bonus on machinery investment to replace old machinery during the first half of the year. When the bonus finally expires in July 2010, it is likely there will be a sizeable capex correction. As a result Unicredit expect machinery investment to drop 0.9% in 2010 following a likely -16% in 2009.<br /><br /><br /><strong>Official Figures Underestimate Unemployment</strong><br /><br />In November 2009 the Italian unemployment rate reached 8.3% in Novemember, as compared to 7.0% a year earlier. The European Commission expects the annual unemployment rate to rise to 7.8%in 2009 and 8.7% in 2010. The OECD's November 2009 economic outlook also expects Italian joblessness to peak in 2011 at 8.7%.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEipg4xehgzmlxPINMqe9DIR8R5nUH_02EUjjTdOCXgFUdESf-Rr7HOcJwwhTrTntOW6buiDW8ML8JxFSSuvqXyG1ift8iqaeaYj91lO8PUxfIg4Y75e4bBjqKPWoKWtdTVP1SOy-A/s1600-h/Italy+Unemployment+Rate.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 221px" id="BLOGGER_PHOTO_ID_5427408803106947218" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEipg4xehgzmlxPINMqe9DIR8R5nUH_02EUjjTdOCXgFUdESf-Rr7HOcJwwhTrTntOW6buiDW8ML8JxFSSuvqXyG1ift8iqaeaYj91lO8PUxfIg4Y75e4bBjqKPWoKWtdTVP1SOy-A/s400/Italy+Unemployment+Rate.png" /></a><br /><br />But the EU harmonised method of calculating unemployemnt rather underestimates the situation in the Italian case, and Italy’s real unemployment rate is significantly higher (<a href="http://www.bloomberg.com/apps/news?pid=20601085&sid=aneX9qAAafOk">around 10.7% according to Bloomberg calculations</a>) once you add-in those workers paid by a fund known as cassa integrazione, or CIG. The CIG pays laid off employees about 80 percent of their salaries for up to two years.<br /><br />Again Bloomberg calculate that use made by Italian companies’ of the CIG fund quadrupled to almost 1.5 billion euros in 2009 from 365 million euros in 2008. The official cost of the CIG in 2009 will be published in the annual report of INPS (the Rome-based agency that handles the welfare payments) later this year. Under Italian law, businesses suffering from a downturn can lay off permanent employees for as long as two years and take them back when conditions improve. In fact CIG aid can be extended to five years if the government decides that circumstances are “exceptional.” <br /><br /><strong>Difficult Years Ahead If Italy Wants To Consolidate Its Fiscal Position</strong><br /><br />The overnment's response to the present crisis has been - at least formally - rather moderate due to the need to avoid a substantial deterioration in public finances, given the very high level of already existing government debt in a context of increased global risk aversion. Evidently the Italian government didn't want to draw attention to itself in the way the Greek one has. As a result measures taken to support low-income groups and key industrial sectors have been largely financed by reallocating existing funds, and this is even largely true of the additional stimulus package of 4.5 billion euros, in an effort to "intensify actions against the crisis," according to Minister of the Interior Claudio Scajola in a statement at the time.<br /><br />However, even given this evident restraint, the EU Commission sill forecast that the government deficit probably widened to 5.3% of GDP in 2009 (from 2.7% in 2008) and remain at around that level in both 2010 and 2011. In comparison to other EU country deficits this is not big beer, but it does need to be situated within the context of the long history of public indebtedness in Italy.<br /><br />Primary expenditure looks likely to have risen by more than 4.5% in 2009, significantly faster than planned in the stability programme update submitted to the EU Commission in February 2009. In particular, public sector wage growth is continuing to outpace inflation. In addition, government financed consumption via social transfers grew considerably in 2009 due to a combination of pensions being indexed to the previous-year's inflation, one-off transfers to poor households and the extended coverage of the wage supplementation fund. Capital spending also rose by an estimated 13%, as a result of recovery measures that bring forward some previously agreed investment plans. The only significant item expected to decrease is interest expenditure, which is benefitting from historically low short-term interest rates.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiNOaV3CyW19JcXxJAsWKgSsJ6W5yXnI85yT6j9Hsh7lR0yoBwDtb1HFt6ZsDglFfr5mjUXOkNJCijJxeREdlz6HR0WQdmUGBZKLh2X1ZDyYPVa4wW4uObL5HqIfjLaqP34GNO-zA/s1600-h/italy+fiscal+deficit.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 209px; CURSOR: pointer" id="BLOGGER_PHOTO_ID_5427410490836047490" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiNOaV3CyW19JcXxJAsWKgSsJ6W5yXnI85yT6j9Hsh7lR0yoBwDtb1HFt6ZsDglFfr5mjUXOkNJCijJxeREdlz6HR0WQdmUGBZKLh2X1ZDyYPVa4wW4uObL5HqIfjLaqP34GNO-zA/s400/italy+fiscal+deficit.png" /></a><br /><br />While the strength of the 2009 downturn understandably derailed the three-year budgetary consolidation plan adopted in summer 2008, a marked slowdown in expenditure dynamics is likely in 2010 and 2011, as the government attempts a return to the planned consolidation path. Capital expenditure is set to decrease in both years, while modest increases are projected for current primary expenditure. Interest expenditure is also expected to rise, due to monetary policy decisions at the ECB and the expanding size of the debt itself.<br /><br />The EU Commission estimate that the gross government debt-to-GDP ratio climbed by almost 9 percentage points in 2009, to around 114.5%, and forecast that it will continue rising to around 118% in 2011. The 2009 increase is overwhelmingly due to the sharp fall in nominal GDP. Looking forward, the EU Commission emphasise that ongoing interaction between high debt-service requirements and Italy's low potential GDP growth rate underlines the importance of raising the primary balance so as to put the very high debt ratio on a declining path once again.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjH_4sWSXmEpK4jmRqBaZENt8S5hFp-o_gxFXaeawn7k0ibVfRKpb9SnxmXsaB7sbkGGo_WZ1n54PfBeAUGAv2XK7UIzRyQ_EW1PaCEIodfQUrEN5DXfNe4_LcKnj882X9ImFlwrQ/s1600-h/Italy+Government+Debt.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 227px; CURSOR: pointer" id="BLOGGER_PHOTO_ID_5427410396928750866" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjH_4sWSXmEpK4jmRqBaZENt8S5hFp-o_gxFXaeawn7k0ibVfRKpb9SnxmXsaB7sbkGGo_WZ1n54PfBeAUGAv2XK7UIzRyQ_EW1PaCEIodfQUrEN5DXfNe4_LcKnj882X9ImFlwrQ/s400/Italy+Government+Debt.png" /></a><br /><br />In this context, one of the concerns about Italy's government debt trajectory is the extent of recourse to one-off and make-and-mend measures to keep the state finances afloat. One good example of such a measure are the tax amnesties, a technique which Italian Finance Minister Guilgio Tremonti has had considerable experience with, since in both 2001 and 2003, as part of an earlier Berlusconi government, he enacted similar measures that brought some 20 billion euros back to Italy, with a further 15 billion euros being declared by Italian clients of Lugano banks, though it remained in Switzerland. But the yield the first time round has been dwarfed by the rich harvest this time. Mr. Tremonti recently announced that Italians had declared 95 billion euros in assets under the plan, with some 98% of the money being brought into Italy from offshore sources. The harvest should have added something like 5 billion euros to 2009 Italian tax revenue, and although the plan formally expired on December 15, a further ammnesty period is not ruled out.<br /><br />In fact the Italian Finance Minister has often come under attack from those who want to see the government taking more decisive action against the economic crisis, but his insistence on fiscal prudence appears to have been justified, given the difficulties currently facing Greece. For once an Italian government can be congratulated for its prudence, and the risk premium on Italian government bond yields was just overcompared with benchmark German bunds is running somewhere around 80 basis points as compared with Greece, where the spread is now over 250 basis points.<br /><br />Resources are also being acquired from the Trattamento di fine rapporto (TFR), a fund containing contributions paid by employers for employees' severance pay when they retire, leave their jobs or are made redundant. Although there is little doubt that the government will eventually reimburse the money, it is likely that it will have to resort to increased taxation or cuts in expenditure to do so.<br /><br />So the issue is, that far from using the crisis as a justification for implementing the much needed deep-seated reform, it has instead and once more been used as an excuse for postponing it. I leave you with the words of The Italian economist Francesco Davieri, <a href="http://www.voxeu.org/index.php?q=node/3612">writing last June in the economics portal VOX EU</a>:<br /><blockquote>If Italy’s government does not push reform more aggressively – issues like pension reform, the schooling and university system, and the labour market – the most likely scenario is that the Italian economy will return to its usual...[lacklustre]....annual growth after the crisis. This is why postponing reforms in today’s Italy is like consuming a luxury good when you are close to starvation. Today’s Italy just can’t afford it, if it wants to resume faster long-run growth.</blockquote>Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-3949752.post-38460741009547208402009-06-20T12:29:00.001+02:002009-06-20T12:33:50.907+02:00Facebook LinksQuietly clicking my way through Bloomberg last Sunday afternoon, <a href="http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aC4zbsgMD6x8">I came across this</a>:<br /><br /><br /><blockquote><strong>Facebook Members Register Names at 550 a Second</strong><br /><br />Facebook Inc., the world’s largest social-networking site, said members registered new user names at a rate of more than 550 a second after the company offered people the chance to claim a personalized Web address.<br /><br />Facebook started accepted registrations at midnight New York time on a first-come, first-served basis. Within the first seven minutes, 345,000 people had claimed user names, said Larry Yu, a spokesman for Palo Alto, California-based Facebook. Within 15 minutes, 500,000 users had grabbed a name. </blockquote><br /><br />Mein Gott, I thought to myself, if 550 people a second are doing something, they can't all be wrong. So I immediately signed up. Actually, this isn't my first experience with social networking since I did try Orkut out some years back, but somehow I didn't quite get the point. Either I was missing something, or Orkut was. Now I think I've finally got it. Perhaps the technology has improved, or perhaps I have. As I said in one of my first postings:<br /><br /><blockquote>Ok. This is just what I've always wanted really. A quick'n dirty personal blog. Here we go. Boy am I going to enjoy this.</blockquote>Daniel Dresner once broke bloggers down into two groups, the "thinkers" and the "linkers". I probably would be immodest enough to suggest that most of my material falls into the first category (my postings are lo-o-o-ng, horribly long), but since I don't fit any mould, and Iam hard to typecast, I also have that hidden "linker" part, struggling within and desperate to come out. Which is why Facebook is just great.<br /><br />In addition, on blogs like this I can probably only manage to post something worthwhile perhaps once or twice a month, and there is news everyday.<br /><br />So, if you want some of that up to the minute "breaking" stuff, and are willing to submit yourself to a good dose of link spam, why not come on in and subscribe to my new state-of-the-art blog? You can either send me a friend request via FB, or mail me direct (you can find the mail on my Roubini Global page). Let's all go and take a long hard look at the future, you never know, it might just work.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-3949752.post-89137346096272105062009-04-27T19:09:00.018+02:002009-05-15T18:22:32.832+02:00Italian GDP Falls An Annualised 9.6% In The First Three Months Of 2009Italy's recession deepened at the start of 2009, with first-quarter gross domestic product falling to its worst level since at least 1980, confirming the impression that Europe's fourth-largest economy is now headed for its worst downturn since World War II. Preliminary data from the national statistics office (Istat) show that Italian GDP fell 2.4% in the first quarter when compared with the last quarter of 2008. This follows a downwardly revised 2.1% contraction in the fourth quarter of last year. Annualised this means a 9.6% contraction rate during the three months, which is very high indeed.<br /><br /><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhnzOpcILMwpojIPNTuCOnjpYBL6LKRDR2I6Xp3TWdE0UYciI4lsfG9warpFrtDUYVcUKt2-gI60sstcmXr714rTepErlUzA6qeiiOVcRi-sGYIrqX58aFWqHh2dFHusCBHqVwDhg/s1600-h/italy+GDP+one.png"><img id="BLOGGER_PHOTO_ID_5335970131734742786" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 229px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhnzOpcILMwpojIPNTuCOnjpYBL6LKRDR2I6Xp3TWdE0UYciI4lsfG9warpFrtDUYVcUKt2-gI60sstcmXr714rTepErlUzA6qeiiOVcRi-sGYIrqX58aFWqHh2dFHusCBHqVwDhg/s400/italy+GDP+one.png" border="0" /></a><br /><br /><br />Year on year GDP fell by 5.9%, which was also the sharpest drop since Istat's most recent data series starts in 1980 - or for at lest 29 years. The contraction was even worse than analysts were predicting, with the consensus having been for a 1.8% drop on the quarter and a 5% one on the year. </p><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgO0I7hmOb2bxydIv_aTY6C7_7mkmybuIXzprB_piiN5G-ssEPdySd9OtpHPDlBchstVgiGfOIHKtiuhYQICKc4sgfWNlokoCjinDaKWyB8P4lkTXXU5eqyJjkD8q-BzRcAW4dm_w/s1600-h/italy+gdp+two.png"><img id="BLOGGER_PHOTO_ID_5335970068543599954" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 230px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgO0I7hmOb2bxydIv_aTY6C7_7mkmybuIXzprB_piiN5G-ssEPdySd9OtpHPDlBchstVgiGfOIHKtiuhYQICKc4sgfWNlokoCjinDaKWyB8P4lkTXXU5eqyJjkD8q-BzRcAW4dm_w/s400/italy+gdp+two.png" border="0" /></a> According to ISTAT, even if GDP stays flat for the remaining three quarters of the year, 2009 GDP will contract by 4.6%. According to my rough calculations, Italy's GDP was on about the same level this quarter as it was in the first three months of 2005, and from here we are travelling back in time.</p><p><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjEsShh95Xmuj1VknkBs8XvEo1-5zj5gDnIX_X2AAT62krTXE7pUPUeO4G8Wbzp5a-GsmZGEkF3W-ygJan3EEVXEZhut-f4LBAnoQVH0zcQmUbZy6TQh8fU-ppSceQ7xnQph4yxXw/s1600-h/italian+GDP+3.png"><img id="BLOGGER_PHOTO_ID_5336079102768687314" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 230px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjEsShh95Xmuj1VknkBs8XvEo1-5zj5gDnIX_X2AAT62krTXE7pUPUeO4G8Wbzp5a-GsmZGEkF3W-ygJan3EEVXEZhut-f4LBAnoQVH0zcQmUbZy6TQh8fU-ppSceQ7xnQph4yxXw/s400/italian+GDP+3.png" border="0" /></a><br /><br />But GDP is not remaining flat, even if the pace of contraction seems to have slowed in the present quarter.<br /><br /><strong>PMIs Show Continuing Contraction - Although The Rate Eased In April</strong><br /><br />Italy continued to register the steepest overall fall in retail sales in the Eurozone in April according to the Bloomberg Retail PMI. The month-on-month sales index did however rise from 41.9 in March to 46.8 giving the slowest rate of decline since October 2007. Retail sales have now fallen for 26 months consecutively according to survey data.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgUjzc7a9L6FmGXrXA1gtAoTcuaONMWyCAxgCq1OSWklb1qTYSWm_26futow0wWW6wGkhDBf1mnTWB3RvJJ-GjAiwbjFGqThiH07w1KE66kHj8TLJi7BSrdudPHYPzxtqB9EbNmNg/s1600-h/italy+retail+Sales.png"><img id="BLOGGER_PHOTO_ID_5331694476710179874" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 206px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgUjzc7a9L6FmGXrXA1gtAoTcuaONMWyCAxgCq1OSWklb1qTYSWm_26futow0wWW6wGkhDBf1mnTWB3RvJJ-GjAiwbjFGqThiH07w1KE66kHj8TLJi7BSrdudPHYPzxtqB9EbNmNg/s400/italy+retail+Sales.png" border="0" /></a><br /><br /><strong>Manufacturing Output Falls</strong><br /><br /><br />Italy's manufacturing business shrank at its slowest rate for six months in April, with the latest Markit/ADACI survey producing a headline PMI reading of 37.2 - significantly above March's record low of 34.6 and beating the consensus forecast of 36.5.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjPgx57awc0a5O8StPig0o97ggSgC4m887_yn710O9IExQq2Qvt2iIs4UT4uqbu6Q4JBo0ktfrWqJb2GA61nasjbhHkQDiaT8tZKSsAuK7jQ4gzij6xlgw3baPfyJw8m_VamMiV5A/s1600-h/italy+pmi.png"><img id="BLOGGER_PHOTO_ID_5331938950452174770" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 213px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjPgx57awc0a5O8StPig0o97ggSgC4m887_yn710O9IExQq2Qvt2iIs4UT4uqbu6Q4JBo0ktfrWqJb2GA61nasjbhHkQDiaT8tZKSsAuK7jQ4gzij6xlgw3baPfyJw8m_VamMiV5A/s400/italy+pmi.png" border="0" /></a><br /><br />In addition other recent data suggest that the lowest point may have been past with business confidence improving in April (following 10 consecutive monthly falls), and consumer morale hitting its highest level in 16 months. However Markit reported that about 40 percent of companies in the survey reported new order levels continued to fall during the month, even though at the slowest rate of decline in seven months. Output fell at its slowest rate since October, with the sub-index jumping to 35.9 in April from 32.8 in March. Overseas orders, even though they fell less sharply in April, still clocked up their 14th successive month of decline, with Markit noting that demand was particularly weak from Eastern Europe and Russia. </p><p>And job losses in Italy's manufacturing sector showed no signs of letting up and were running at the second fastest rate in almost 12 years of data collection following the record low hit by the employment index in March.<br /><br />However, saying that the "darkest hour" in this contraction may be over is not the same thing as saying that recovery is anywhere in sight. Italy's manufacturing PMI has now not indicated growth since February 2008 and forecasts generally expect the economy to contract by around four percent this year, making for two straight years of continuous contraction for the first time since World War Two. Indeed, the Organisation for Economic Cooperation and Development has even already pencilled in a potential further contraction for 2010, which if realised will mean Italy's economy will have been shrinking for an almost unprecedented 3 years continuously.<br /><br /><br /><strong>As Does Services</strong><br /><br />Italian service sector activity contracted for the 17th consecutive month in April although at the slowest rate for six months. The Markit/ADACI Purchasing Managers' Index rose to 42.0 from 39.1 in March, but still is not that far above the record low of 37.9 recorded in February. Activity has now been stick below the 50 mark that separates growth from contraction since November 2007. </p><p></p><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEha9JlA4sdIYwfR8HmWIdVi5MZZcGeN3u1kpTtEs_99xG6to_2WmUQzgZO87IUAOapoQIVG3nMcDUqLguKiXktGZeiEVd3-CHmwHx8UGOkNjriTia5WPzM5e_NxuOkoat7G2a7xRw/s1600-h/italy+services.png"><img id="BLOGGER_PHOTO_ID_5332694346424031762" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 212px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEha9JlA4sdIYwfR8HmWIdVi5MZZcGeN3u1kpTtEs_99xG6to_2WmUQzgZO87IUAOapoQIVG3nMcDUqLguKiXktGZeiEVd3-CHmwHx8UGOkNjriTia5WPzM5e_NxuOkoat7G2a7xRw/s400/italy+services.png" border="0" /></a></p><p>The survey showed new business shrinking for the eighteenth straight month in April, though the rate of decline eased for the second month running, while expectations of business in a year's time rose to an eight-month high. As elsewhere, while optimism is rising Markit did point to record job losses as a likely on consumer spending looking ahead, making hopes of a swift recovery extremely premature. The employment sub-index fell to 44.0 from 44.6, as firms cut jobs at a survey record rate in response to the ongoing loss of business. The survey is thus consistent with other recent indicators that have pointed to an economy still mired in the deep recession that began in spring of last year, but with some grounds for thinking that the lowest point may now have been passed.<br /><br />Deflationary pressure remained evident with service firms cutting their prices for the seventh month running and at the fastest rate in the survey's history in response to weak demand, while input prices showed no monthly increase for the first time since the survey began. The Italian government slashed its economic forecasts last week, and now project gross domestic product to fall by 4.2 percent this year following last year's 1.0 percent decline. The International Monetary Fund is more pessimistic, forecasting a 4.4 percent fall this year and a further drop of 0.4 percent in 2010. Italy thus now possibly faces three years of economic contraction one after the other although previously the country had not posted two consecutive years of falling GDP in its entire post-war history.<br /><br /><strong>Business and Consumer Confidence Rebound Slightly</strong><br /><br /></p>Italian consumer confidence rebounded slightly in April and reached its highest level since December 2007 as the lure of slowing inflation seemed to offset concerns about rising unemployment. The Isae Institute’s consumer confidence index rose to 104.9 from 99.8 in March.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjH2XoqxfsYZqI4mHgzMnnfc6L0Xkz3cZ32jMsjX20tL1si6k_6swRzGlCK_rxxJsO06a5gb2vI3tiVFKPVtCjMwTD5Pb0VAl9n8v3qjuYu_9mE0iSq7imEpVw8eI7lJPnO440XLA/s1600-h/italy+cc.png"><img id="BLOGGER_PHOTO_ID_5329420005299013938" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 220px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjH2XoqxfsYZqI4mHgzMnnfc6L0Xkz3cZ32jMsjX20tL1si6k_6swRzGlCK_rxxJsO06a5gb2vI3tiVFKPVtCjMwTD5Pb0VAl9n8v3qjuYu_9mE0iSq7imEpVw8eI7lJPnO440XLA/s400/italy+cc.png" border="0" /></a><br />Italian business confidence also rose as companies saw signs of an increase in orders of goods and services following the sighting of green sprouts everywhere except under our noses. The Isae Institute’s business confidence index climbed to 64.2 from a revised 60.9 in March.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhBCa53_VqPitvdPVGrZ-IZRoJU1pjyuFiVnzIC4aOiTfJyGWWSCS4lh3EvOEDej-mSzrX4c0bX_PByanfKklZIOop6OWZtAS9mD6aNs-kqzttz47K43gH6jPJXKacEo2ijRlpkzQ/s1600-h/italy+bus+con.png"><img id="BLOGGER_PHOTO_ID_5329732713605174546" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 188px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhBCa53_VqPitvdPVGrZ-IZRoJU1pjyuFiVnzIC4aOiTfJyGWWSCS4lh3EvOEDej-mSzrX4c0bX_PByanfKklZIOop6OWZtAS9mD6aNs-kqzttz47K43gH6jPJXKacEo2ijRlpkzQ/s400/italy+bus+con.png" border="0" /></a><br /><br /><br /><strong>Industrial Output</strong><br /><br /><br />Industrial output simply declined and declines, and fell in March for an 11th consecutive month. Output dropped a seasonally adjusted 4.6 percent from February, when it fell a revised 4.6 percent, according to data from the national statistics office. From a year earlier, adjusted production fell 23.8 percent. Fiat has laid off about half of its 78,000 national workforce in using temporary state-subsidized programs. Sales of their cars fell 16 percent in Italy in the first quarter, according to data from the trade association ANFIA.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgz83RolQ-obud_10IOMNyl8qz3Rbu1wi_3OKOrbY_tu33lLz0r3Jbr0rNHBBSHuWtdwbNnGpXA5xsxvWzbOw4VD63zYwnAGM9azt5tumARQU-8-A0B1LyzlnQ7vj9fu3pRSVIHGA/s1600-h/italy+IP+two.png"><img id="BLOGGER_PHOTO_ID_5334490702715699154" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 204px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgz83RolQ-obud_10IOMNyl8qz3Rbu1wi_3OKOrbY_tu33lLz0r3Jbr0rNHBBSHuWtdwbNnGpXA5xsxvWzbOw4VD63zYwnAGM9azt5tumARQU-8-A0B1LyzlnQ7vj9fu3pRSVIHGA/s400/italy+IP+two.png" border="0" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgN7Ns9ayLF-BgoeM3jvt-_mE5pR-QV2ooLochk_pL5Rg2RSRqZ015_E0YidQ4OWiuuVWZRTCZnDz9rKngD1G1nZoZXzguznCboBE8sgrLnD8KzxmeS1ekqY1CoP8CL-kUnpE0I5Q/s1600-h/italy+IP+one.png"><img id="BLOGGER_PHOTO_ID_5334490609798744418" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 189px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgN7Ns9ayLF-BgoeM3jvt-_mE5pR-QV2ooLochk_pL5Rg2RSRqZ015_E0YidQ4OWiuuVWZRTCZnDz9rKngD1G1nZoZXzguznCboBE8sgrLnD8KzxmeS1ekqY1CoP8CL-kUnpE0I5Q/s400/italy+IP+one.png" border="0" /></a><br /><strong>Exports Remain Very Weak</strong><br /><br />Italy's trade deficit increased dramatically to 837 million euros in February, almost double the 449 million euros recorded in the same month in 2008. Istat said a fall in demand was recorded in all sectors, but the automobile sector was particularly hard hit with a fall in exports of 46 percent. Trade in the chemical sector was down 29.5 percent, electrical goods were down 27.3 percent and exports of other manufactured goods fell by 22.7 percent.<br /><br /><br /><br />Imports were down by 25.3 percent at 24.3 billion euros while exports were down by 23.7 percent at 23.5 billion euros. The results, however, were slightly better than in January, when imports were 23.4 billion euros and exports 19.8 billion euros. This was effectively the worst decline in exports since these statistics were first compiled by ISTAT in 1993.<br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgrpRZD85Owz5Hy4gdU08hutG2L6CY7wFEY1am2CYxXU_BLmdaNaHryiOaOHnIOqQsQzUyNgQvMRNAzxra0VFt2IWnubNZYHPuF8v2ef7bs6ZAdiGCLve4OhiEmXs7I9fB7p6m6Kw/s1600-h/Italy+exports.png"><img id="BLOGGER_PHOTO_ID_5334490531592351090" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 205px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgrpRZD85Owz5Hy4gdU08hutG2L6CY7wFEY1am2CYxXU_BLmdaNaHryiOaOHnIOqQsQzUyNgQvMRNAzxra0VFt2IWnubNZYHPuF8v2ef7bs6ZAdiGCLve4OhiEmXs7I9fB7p6m6Kw/s400/Italy+exports.png" border="0" /></a><br /><br /><strong>No End To The Recession In Sight</strong><br />Italy effectively entered recession in third quarter of 2008, and the economy now looks bound to shrink the most in more than half a century this year. The International Monetary Fund forecast on April 22 that the jobless rate will reach 8.9 percent this year and 10.5 percent in 2010. At the same time, Italian inflation has been slowing and hit a record low of 1.1 % in March, so if the contraction continues the deflation threat is real and present.<br /><br />According to the latest EU Commission forecast Italy’s gross domestic product will fall this year by 4.4 percent, more than twice the 2 percent it predicted three months ago. This is bound to have a substantial impact on government debt, and the Italian government already accepts that the budget deficit will rise this year and breach the European Union limit of 3 percent of GDP. Government spending climbed 21 percent in the first quarter from a year earlier, while revenue fell 4.8 percent, the Bank of Italy said on May 13. The EU Commission forecast a deficit of 4.5% of GDP this year and 4.8% in 2010. As a result gross government debt is projected to climb from 105.8% of GDP in 2008 to 113% in 2009 and 116.1% in 2010. A grim picture, and no easy solutions.Unknownnoreply@blogger.com9tag:blogger.com,1999:blog-3949752.post-66631730426589580692009-04-09T09:46:00.000+02:002009-04-09T13:16:52.162+02:00Italian Industrial Output Continues To Decline In FebruaryIndustrial production in Italy fell for the eighth month in February as the nation’s worst recession in more than 30 years forced companies to cut output. Production in the euro region's third biggest economy dropped a seasonally adjusted 3.5 percent from January, when it fell a revised 1.2 percent. From a year earlier, working day adjusted production fell 21 percent. The monthly decline was more than the 1.5 percent median forecast of 18 economists surveyed by Bloomberg. <br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEispEsb02AtZNPQhi_3wwA1O5HwWuqKqlToFc6gY-Dr1d1KdnpQeUldSD34IQ31q1DeGzgEHV55vCsQWP6P6xgqLc8epg99Yj5Z2TKrrCVoe8uFZdswW_czQQ2umOKDx4PHqoF-nw/s1600-h/italy+IP+1.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 206px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEispEsb02AtZNPQhi_3wwA1O5HwWuqKqlToFc6gY-Dr1d1KdnpQeUldSD34IQ31q1DeGzgEHV55vCsQWP6P6xgqLc8epg99Yj5Z2TKrrCVoe8uFZdswW_czQQ2umOKDx4PHqoF-nw/s400/italy+IP+1.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5322645820967640818" /></a><br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjrrcsB5Lsc7gqatXcIdTcuEQArvwikR3rV9v3ejXIs2iCL2F5gBgP5EDlBHCwTcBJXjwsGgly9Wu2mv_BnrCHOrXApFu-idGtFLAhHoPyS3IlJPtR9H6SpJ5MRu9tVTrRZBNP8lg/s1600-h/italy+IP2.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 187px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjrrcsB5Lsc7gqatXcIdTcuEQArvwikR3rV9v3ejXIs2iCL2F5gBgP5EDlBHCwTcBJXjwsGgly9Wu2mv_BnrCHOrXApFu-idGtFLAhHoPyS3IlJPtR9H6SpJ5MRu9tVTrRZBNP8lg/s400/italy+IP2.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5322644450435305826" /></a><br /><br />And the picture doesn't seem to have improved any in March, since manufacturing activity fell in Italy at its fastest pace on record, with the manufacturing purchasing managers index falling to a record low of 34.6, down from February's 35.0 and suggesting an unprecedented contraction in activity for the sector. Weakness was widespread, Markit said in their report. Staffing levels were cut at a record pace as firms were forced to adapt to falling workloads and declining new orders. Backlogs of work also declined at their sharpest pace in the history of the PMI as falling demand meant firms to were increasingly able to complete outstanding projects.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEilowz7dm8O12-1ydLl7M8L4W_ZASWO1O1wQk6kI3qM8-FCVebNnkmkvK1rKYb0e3suU_8UySrquragNPflN1R9kvARW2g1ln6FHnD2yJTk4y2ikKsgrttPT0AhGcVz_VkO8IwFLA/s1600-h/italy+PMI.png"><img id="BLOGGER_PHOTO_ID_5319729536503154866" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 212px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEilowz7dm8O12-1ydLl7M8L4W_ZASWO1O1wQk6kI3qM8-FCVebNnkmkvK1rKYb0e3suU_8UySrquragNPflN1R9kvARW2g1ln6FHnD2yJTk4y2ikKsgrttPT0AhGcVz_VkO8IwFLA/s400/italy+PMI.png" border="0" /></a><br /><br /><br /><strong>The Contraction In Italian Services Continues</strong><br /><br /><br />Italian service sector activity also stayed close to record lows in March, with employment falling the fastest in over 11 years, according to the PMI survey released last Friday. The Markit/ADACI Purchasing Managers' Index, spanning companies from hotels to insurance brokers, edged up to 39.1 after hitting 37.9 in February, its lowest level since the survey began in January 1998.<br /><br />The headline measure has not been above the 50 mark that separates growth from contraction since November 2007, and the survey showed jobs were shed in March at a record pace. The survey also showed that companies' input costs and the prices they charged customers were falling at the fastest rate since the series began as firms scrambled to offer discounts to attract business.<br /><br /><blockquote>"Averaged over the quarter, service sector activity fell at the fastest pace since at least 1998," said Andrew Self, economist at Markit Economics. "The slump is in line with a year-on-year contraction of gross domestic product between 2.5 and 3.0 percent. This implies economic output will contract at a sharper pace in the first quarter, on a quarterly basis, than in the last quarter of 2008."</blockquote><br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhXVt8f48v6AWlh9K_QDlnC6PDjav82XvsfcyM9T79T02VJEo9qYXqTcRoawTR2NLa8l9LD09MlbNfMG9h15Pbgf_KsXaOzBJ5_wYXXGaoXLdm4JXYA6NVfqaGLnmj6WeY-1-FyNw/s1600-h/italy+services+PMI.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 211px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhXVt8f48v6AWlh9K_QDlnC6PDjav82XvsfcyM9T79T02VJEo9qYXqTcRoawTR2NLa8l9LD09MlbNfMG9h15Pbgf_KsXaOzBJ5_wYXXGaoXLdm4JXYA6NVfqaGLnmj6WeY-1-FyNw/s400/italy+services+PMI.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5321667369367956258" /></a><br /><br /><br />The Organisation for Economic Cooperation and Development forecast last week that Italy's GDP would plunge 4.3 percent this year and fall 0.4 percent in 2010, giving Italy three consecutive years of economic contraction. According to the OECD unemployment will jump to 9.2 percent after rising in 2008 for the first time in a decade to 6.8 percent.Unknownnoreply@blogger.com5tag:blogger.com,1999:blog-3949752.post-13771022934223906172009-03-30T18:30:00.001+02:002009-03-30T18:32:57.417+02:00Eurozone Retail Sales Contract For the Tenth Month In SuccessionThe Bloomberg Euro-Zone Retail Purchasing Managers' Index - based on a mid-month survey of more than 1,000 executives in the euro area retail sector - rose marginally in March - to 44.1, up from 42.3 in February to 44.1 in March. This was the smallest monthly drop in the value of sales in five months, but it was still a drop, and quite a significant one, since the neutral point between contraction and expansion is 50. Still first quarter retail sales have seen an average monthly decline which is smaller than in the fourth quarter of last year (an effect of all those stimulus programmes), however sales have now fallen for ten consecutive months.<br /><br /><strong>The German Sales Contraction Accelerates<br /></strong><br />Retail sales in Germany, the zone's largest economy, dropped for a 10th month in March as unemployment rose and manufacturing industry continued to grapple with a slump in export orders. The retail PMI dropped to 44.4 from 45.4 in February.<br /><br />German households are cutting spending as a deepening economic slump forces companies to eliminate jobs, pushing up unemployment. The fall comes despite the decision of German Chancellor Angela Merkel to spend about 82 billion euros in measures to stimulate growth, including tax breaks and incentives to buy new cars.<br /><br /><blockquote>“Consumers were generally unwilling to spend, while evidence of shorter working hours at local companies reportedly curtailed their buying power,” Markit said in the statement. “The overall decline may have been greater were it not for government incentives to scrap old motor vehicles, which continued to support sales in the automobile sector.” </blockquote><br /><br /><br /><br /><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiM07mWSBVAYv-e1dAFu4Yzb1HxwE-XkwnsI3XiKgRQ_AxnRx5trn4QWe2zZ2GxRHdU8q78Khhw9kgkS9Ti1P5HUBhFTuMyKtVtHuhEXhTaP_VwnCp99As_uNbKxMVKC4-pTyVBdQ/s1600-h/germany+retail+pmi.png"><img id="BLOGGER_PHOTO_ID_5318948289977819698" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 216px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiM07mWSBVAYv-e1dAFu4Yzb1HxwE-XkwnsI3XiKgRQ_AxnRx5trn4QWe2zZ2GxRHdU8q78Khhw9kgkS9Ti1P5HUBhFTuMyKtVtHuhEXhTaP_VwnCp99As_uNbKxMVKC4-pTyVBdQ/s400/germany+retail+pmi.png" border="0" /></a> </p><p><strong>The Italian Sales Contraction Enters Its 25th Month<br /></strong><br />Italian retail sales contracted for a 25th month in March <a href="http://italyeconomicinfo.blogspot.com/2009/03/italys-economic-contraction-accelerates.html">as the country's worst recession in more than 30 years</a> prompts companies to cut jobs, in the process eating away at consumer demand. The index was up slightly at 41.9, from 38.2 in February.</p><p>Italy slipped into its fourth recession since 2001 last year, sending the unemployment rate to a two-year high. The government has adopted around 40 billion euros in stimulus measures, but is constrained from spending more due to the high level of prior government debt. As a result the OECD forecast the economy will likely contract by 4.2 percent this year. </p><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhST07j3XnGPH7KjCF-4Nttc5ZYzNfeMay1o9vsh-C8Q0M7lWZPO10V9gmkZJMFNEiXUTl91N6urSjqnO7S_9lXJlxeeCLkanEaHwrkS8pFVcfuqEOtDzU5tQzLk_6-mebQeCs0FA/s1600-h/italy+retail+pmi.png"><img id="BLOGGER_PHOTO_ID_5318949574610689010" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 206px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhST07j3XnGPH7KjCF-4Nttc5ZYzNfeMay1o9vsh-C8Q0M7lWZPO10V9gmkZJMFNEiXUTl91N6urSjqnO7S_9lXJlxeeCLkanEaHwrkS8pFVcfuqEOtDzU5tQzLk_6-mebQeCs0FA/s400/italy+retail+pmi.png" border="0" /></a><br /><strong>French Sales Hold Up A Little Better</strong></p><p><br />France also saw a moderation in the rate of sales decline, with the pace easing from February's record but remaining steep. Month-on-month the index rose from 42.6 to 45.7, rounding off a first quarter that has seen the weakest sales performance in the history of the French survey. French retailers have reported falling sales in five of the past six months.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhxZ2xBwEYGCjklx1Ty0oEQtO9GvIK8qkyhfwEjitoZ-v72fCJBlQvGvO-Y4LCiQ3b7fY-Js-t4v6zi1g90L4Fz1YPJC33j6Zl75xXVhoCketfKm9hEDxBId4LsEjCb9sIwkX3U0w/s1600-h/france+retail+pmi.png"><img id="BLOGGER_PHOTO_ID_5318950653942468914" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 211px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhxZ2xBwEYGCjklx1Ty0oEQtO9GvIK8qkyhfwEjitoZ-v72fCJBlQvGvO-Y4LCiQ3b7fY-Js-t4v6zi1g90L4Fz1YPJC33j6Zl75xXVhoCketfKm9hEDxBId4LsEjCb9sIwkX3U0w/s400/france+retail+pmi.png" border="0" /></a></p>Unknownnoreply@blogger.com1tag:blogger.com,1999:blog-3949752.post-85888962914415910092009-03-22T19:02:00.014+01:002009-03-26T17:48:06.975+01:00Italy's Economic Contraction AcceleratesThere is no doubt that Italy's economic situation has worsened considerably during this quarter. Only last week the OECD forecast that Italy's gross domestic product is likely to fall by 4.2 percent in 2009. This follows a statement earlier this month where the OECD said the situation in Italy this year and next was "much worse" than it had previously thought, and that Italy would not come out of its recession until "sometime" in 2010 at the earliest. According to the earlier forecast the OECD expected GDP to fall this year by one percent and then by a further 0.8 percent in 2010.<br /><br />The Bank of Italy has also changed its forecast, and now suggest that GDP this year will fall by 2.6 percent. In January (the last time they revised their Italy forecast), the IMF forecast a fall of 2.1 percent. This is almost certain to be revised downwards in the April World Economic Outlook forecast review. Only today the Italian employers’ lobby Confindustria cut its forecast for 2009 GDP , saying the economy will contract by 3.5 percent while public debt will climb to 112.5 percent of GDP.<br /><br />And these forecasts are not drawn like rabbits out of a hat, since evidence of the deterioration in Italy's economic performance is now to be found everywhere, but perhaps nowhere is it clearer than in the most recent exports and industrial output numbers. Italian exports plummeted 26 percent in January from a year ago, the biggest drop since records began in 1991. With the drop in exports leaving the country with a trade deficit of 3.6 billion euros.<br /><br /><br /><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhaW3wz0V34uCDr-l-b_YIg-iG2rX_ImRLYaCHIfWx3Sbj4RO0yfRD1Ux7lkwduetlv4WhBMn-UIkHHhHyBRgR-QnuZipdE_2loUyN-snQCtqYYeYXAMZqPIPIwgvhSjke54zycQg/s1600-h/Italy+exports.png"><img id="BLOGGER_PHOTO_ID_5315333082288893394" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 202px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhaW3wz0V34uCDr-l-b_YIg-iG2rX_ImRLYaCHIfWx3Sbj4RO0yfRD1Ux7lkwduetlv4WhBMn-UIkHHhHyBRgR-QnuZipdE_2loUyN-snQCtqYYeYXAMZqPIPIwgvhSjke54zycQg/s400/Italy+exports.png" border="0" /></a><br /><br />Meanwhile Italian industrial output fell for a fifth month as what is now the country's worst recession in more than 30 years forced companies to keep cutting output and jobs. Production dropped a seasonally adjusted 0.2 percent from December, when it fell a revised 3.9 percent. From a year earlier, adjusted production fell 16.7 percent, the biggest decline since records began in January 1991.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhxvvfAKPDCfEjbH6vXsXOMk2vcTUHkmHt-7BcVCAd-fqbV5cSpQqBc0-nQgsvbIR5LoDmbUbBhd0HM3MtB9QzGRQzXT_rZHmQnR9sFmWzDq3L-rJBMgjNG1g77uhL5HH9JII0GJg/s1600-h/italy+industrial+output.png"><img id="BLOGGER_PHOTO_ID_5315333447349142770" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 203px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhxvvfAKPDCfEjbH6vXsXOMk2vcTUHkmHt-7BcVCAd-fqbV5cSpQqBc0-nQgsvbIR5LoDmbUbBhd0HM3MtB9QzGRQzXT_rZHmQnR9sFmWzDq3L-rJBMgjNG1g77uhL5HH9JII0GJg/s400/italy+industrial+output.png" border="0" /></a><br />As we can see from the revised output index, after remaining pretty much stationary from early 2007, production really started to slump in May 2008, and hasn't looked back since.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhbE1yh0nrsmmGkCEQE9CerNphmztmPqJvbKC4NAYYax2ezLyPZh50cQzE_rBJSsW875VRbJ5RCpYjnHMFzwlzoQwgmsPQI1m5NrSevwZTApFVfj-R4-mbWGGusePaUt-sb0ciLIg/s1600-h/italy+industrial+output+2.png"><img id="BLOGGER_PHOTO_ID_5315335351426199122" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 190px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhbE1yh0nrsmmGkCEQE9CerNphmztmPqJvbKC4NAYYax2ezLyPZh50cQzE_rBJSsW875VRbJ5RCpYjnHMFzwlzoQwgmsPQI1m5NrSevwZTApFVfj-R4-mbWGGusePaUt-sb0ciLIg/s400/italy+industrial+output+2.png" border="0" /></a><br /><br />Italy's manufacturing PMI fell again in February to 35.0 from January's 36.1, and was only marginally above November's series record low of 34.9.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgiBIjIwLA_kUcAcEcaRd0hD7h1RTALaEBtoMSMwUzwGaZAJodrEFtoO_JvKNSGmwafGIADpUX9-61Vaw0rHLxwsQ9ws-mp4Er_-LLRszuaIT_U7V2aBXzc072dbKlQrIj0OmfzXw/s1600-h/italy+manufacturing+pmi.png"><img id="BLOGGER_PHOTO_ID_5316111260877642018" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 210px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgiBIjIwLA_kUcAcEcaRd0hD7h1RTALaEBtoMSMwUzwGaZAJodrEFtoO_JvKNSGmwafGIADpUX9-61Vaw0rHLxwsQ9ws-mp4Er_-LLRszuaIT_U7V2aBXzc072dbKlQrIj0OmfzXw/s400/italy+manufacturing+pmi.png" border="0" /></a><br /><br />Italian business confidence fell to a record low in March as concern that the fourth recession in seven years will damp orders more than offset lower oil prices and borrowing costs. The Isae Institute’s business confidence index dropped to 59.8, the lowest since the index was created in 1986, from a revised 63.2 in February.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjgvPs-Jdtr1r1nbUKlj1QOVv_v0TswyhmWvwxQSaTIwTVF3C90e-Zf2kiyVVJvfoneVFifmhyphenhyphenfvotjQ14dkwsiYImTa29jghSJODWgw5Ii6rzvuSZKidSa-EY9QSmRuvwQP8uSSA/s1600-h/italian+business+confidence.png"><img id="BLOGGER_PHOTO_ID_5317475029896174930" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 191px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjgvPs-Jdtr1r1nbUKlj1QOVv_v0TswyhmWvwxQSaTIwTVF3C90e-Zf2kiyVVJvfoneVFifmhyphenhyphenfvotjQ14dkwsiYImTa29jghSJODWgw5Ii6rzvuSZKidSa-EY9QSmRuvwQP8uSSA/s400/italian+business+confidence.png" border="0" /></a><br /><br /><br />Italian executives also reported having more problems getting credit in February, when the report showed that 40.2 percent of those surveyed said the credit situation worsened, up from 33.5 percent in January. The new orders sub component also fell, to minus 65 from minus 58 in January, the lowest since 1991. And manufacturers’ expectations for production over the next three months fell to minus 24 from minus 20.<br /><br /><strong>Retail Sales Fall</strong></p><p>Italian retail sales contracted for the 24th consecutive month in February as the credit crunch tightened its grip on spending, and consumers put off purchases of cars and home appliances.<br /><br /></p><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh2L7qYBk-DQzJHl6f-jztThuDgxkbsDEJzwGtLzGs86p7y1mWyxv-lzaneffgBVnSGWHSGyZIn4PvHoAfZPtM1sDV3uUTUanuSr_7zuHAACpzpGzn7XOj9Bpl8oeVfLDNcQVS-Pw/s1600-h/Italy+retail+PMI.png"><img id="BLOGGER_PHOTO_ID_5307134583462104482" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 205px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh2L7qYBk-DQzJHl6f-jztThuDgxkbsDEJzwGtLzGs86p7y1mWyxv-lzaneffgBVnSGWHSGyZIn4PvHoAfZPtM1sDV3uUTUanuSr_7zuHAACpzpGzn7XOj9Bpl8oeVfLDNcQVS-Pw/s400/Italy+retail+PMI.png" border="0" /></a><br /><br /><br /><strong>Services Decline Confirms Accelerating Contraction</strong><br /><br />Italian service sector activity sank in February to its weakest level on record, the latest sign of a deepening recession in the euro zone's third largest economy, the latest Markit/ADACI PMI survey and the Index, spanning companies from hotels to insurance brokers, fell to 37.9 from 41.1 in January to hit the lowest level since the survey began in January 1998.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj837c2pEM-C_LGRnur8wcXsuyUYfl6huqlt6JpUy452E9UtYCFy1aeq2gpRAM-YY2V0mdqROD9YHCR0SiOoJf0yTWVnSZyqZPSJdtGZ-Zs89vOU58WvuamVBynplJeEndCBZGPeA/s1600-h/italy+services.png"><img id="BLOGGER_PHOTO_ID_5316110372213039538" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 213px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj837c2pEM-C_LGRnur8wcXsuyUYfl6huqlt6JpUy452E9UtYCFy1aeq2gpRAM-YY2V0mdqROD9YHCR0SiOoJf0yTWVnSZyqZPSJdtGZ-Zs89vOU58WvuamVBynplJeEndCBZGPeA/s400/italy+services.png" border="0" /></a><br /><br /><br /><strong>GDP Growth In Long Term Decline</strong><br /><br />Italian fourth quarter GDP fell a downwardly revised 1.9% from the previous quarter, the largest drop since 1980, compared with a downwardly revised 0.7% contraction in the third quarter of 2008 according to data published by the Italian statistics office Istat last week.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEivFRoHWH9eF2COUUeKI5-AKyzKl4P4Qenpl51qtNF5FP5YNbJw3LA1iukEJw-R_bmC_8YkTN6LIJ8opVVUBDf8fGiGwDLdPX3suJIU19hOj17j9Xp39nv0aour4intYloEx6lAag/s1600-h/italy+yoy+gdp.png"><img id="BLOGGER_PHOTO_ID_5316111740234579410" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 230px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEivFRoHWH9eF2COUUeKI5-AKyzKl4P4Qenpl51qtNF5FP5YNbJw3LA1iukEJw-R_bmC_8YkTN6LIJ8opVVUBDf8fGiGwDLdPX3suJIU19hOj17j9Xp39nv0aour4intYloEx6lAag/s400/italy+yoy+gdp.png" border="0" /></a><br /><br />On a year on year basis GDP fell a downwardly revised 2.9%, also the sharpest drop since 1980.<br /><br />Business investments fell by 6.9% during the quarter, consumer spending fell 0.6%, while exports plummeted 7.4%. As can be seen from the chart below, given the endemic weak state of Italian household consumption, GDP growth tends to follow export growth.<br /><br /><br /></p><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjk9ZlG2D5zF9nsc-6ua2h3rMH55clCKsyAInHL8eKbLm2rfHKZMEXsc1vh4H9ASI9bgFURFJSP7SwQmgffAvXad474ZX6Fu4I0-WxIbHrnaN4gu4zyQENyPRXFzXVUtTOJkwyqxg/s1600-h/italy+gdp+2.png"><img id="BLOGGER_PHOTO_ID_5315389929773385490" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 234px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjk9ZlG2D5zF9nsc-6ua2h3rMH55clCKsyAInHL8eKbLm2rfHKZMEXsc1vh4H9ASI9bgFURFJSP7SwQmgffAvXad474ZX6Fu4I0-WxIbHrnaN4gu4zyQENyPRXFzXVUtTOJkwyqxg/s400/italy+gdp+2.png" border="0" /></a> Although, of course, household consumption has now been falling back sharply since early 2007.</p><p><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgZxaXCkeUHClFIxPHGHQpkwBN06yoV3mQ90dFKZ25UljQW9E7UhYjRu6vXfg8PClcyg4vdouMgVqNcce0YlAdDtkX4hnN0oZx8WPdQYRfrGKGuHXGs7QQpCq3NcVrDMgwDP2jJWw/s1600-h/italy+gdp+one.png"><img id="BLOGGER_PHOTO_ID_5315389826634203554" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 233px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgZxaXCkeUHClFIxPHGHQpkwBN06yoV3mQ90dFKZ25UljQW9E7UhYjRu6vXfg8PClcyg4vdouMgVqNcce0YlAdDtkX4hnN0oZx8WPdQYRfrGKGuHXGs7QQpCq3NcVrDMgwDP2jJWw/s400/italy+gdp+one.png" border="0" /></a><br />2008 data for Italian GDP has now also been published, and again the drop of 1,0% has not been seen since 1975.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgkqkpHgxmr9_cgFcRzH2UOtJ-A-b9D4espW_2TCufNfszlnoqzyPDXyiVNVLlH5V0pu1MbP2fOWgJMpNnDRH-WdDPcl9qXHiF-rG5E08HIXVviaYPn3T7nPln_Duj3gOwvWIG5-Q/s1600-h/italy+GDP.png"><img id="BLOGGER_PHOTO_ID_5315347482111426658" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 195px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgkqkpHgxmr9_cgFcRzH2UOtJ-A-b9D4espW_2TCufNfszlnoqzyPDXyiVNVLlH5V0pu1MbP2fOWgJMpNnDRH-WdDPcl9qXHiF-rG5E08HIXVviaYPn3T7nPln_Duj3gOwvWIG5-Q/s400/italy+GDP.png" border="0" /></a><br /><br />Italy's economy will shrink by around 2.6 percent this year, a member of the Bank of Italy's executive board said on Wednesday, cutting the central bank's previous forecast of a 2.0 percent contraction made in January.<br /><br /><br />Since January, Italian economic data has been consistently bad, with business confidence and purchasing managers' indexes plumbing new record lows. The government pencilled in a forecast of -2.0 percent in its Stability Programme issued in February, but many analysts have cut their forecasts even lower than the BOI. Intesa San Paolo, Italy's largest bank, has a forecast of -2.9 percent.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh8ehglYV8ARzNawVG8Ix00ZupfMo4g5WR4QcsgMb91XDrs_LbCrTJYj_39-hegkSSBlT73kqpfFULTTUkZmLiLexii_1qA3ZRwxaUVfRfQshAikrVdS8k1Eb8_Y-_isX41lyB6sA/s1600-h/italy+investment.png"><img id="BLOGGER_PHOTO_ID_5316118094387250594" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 232px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh8ehglYV8ARzNawVG8Ix00ZupfMo4g5WR4QcsgMb91XDrs_LbCrTJYj_39-hegkSSBlT73kqpfFULTTUkZmLiLexii_1qA3ZRwxaUVfRfQshAikrVdS8k1Eb8_Y-_isX41lyB6sA/s400/italy+investment.png" border="0" /></a><br /><br />While Italy’s unemployment rate rose in the fourth quarter to the highest in more than two years as the recession deepened, prompting companies to reduce production and jobs. Joblessness increased to a seasonally adjusted 6.9 percent from 6.7 in the previous quarter, the Rome-based national statistics office said today. The number of unemployed rose to 1.73 million in the third quarter, when 1.69 million people were out of work.<br /><br /><strong>Little Room To Manouevre As The Credit Crunch Tightens</strong><br /><br />For some time now Italy’s government has been abandoning its optimistic rhetoric and adoptinmg a more sombre assessment of the economy. Giulio Tremonti, the finance minister, recently told a conference that 2009 would be “even more difficult” than last year, with two leading newspapers quoting him as saying Italy faced a “horrible year”.<br /><br />Tremonti said the government would look next week at providing more to help the growing numbers of unemployed, on top of €8bn it says has already been set aside for extra benefits.<br /><br />Italian consumer confidence fell for the first time in three months in March, with the Isae Institute’s consumer confidence index dropping to 99.8 from a revised 104 in February.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjVpe2__Z4ureB0RIt_PFG9-Avwmn-ikxahtpbeLektlmXmS_tESI9veU_AbrwCF3PHcZKhldbPe2Ma1xzzShhWctf-P5kiy4SQ9w8LMVdtl59jXJTygla-Vw9_mg2Z92CcZvTLcg/s1600-h/italy+consumer+confidence.png"><img id="BLOGGER_PHOTO_ID_5317267592822175618" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 221px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjVpe2__Z4ureB0RIt_PFG9-Avwmn-ikxahtpbeLektlmXmS_tESI9veU_AbrwCF3PHcZKhldbPe2Ma1xzzShhWctf-P5kiy4SQ9w8LMVdtl59jXJTygla-Vw9_mg2Z92CcZvTLcg/s400/italy+consumer+confidence.png" border="0" /></a><br /><br />Growing evidence suggests that the crisis is really hitting the Italian economy in a kind of back-to-front fashion, with the slump in the real economy (and especially the economic crisis in the East of Europe) threatening to drive Italian banks into more and more difficulty. The finance minister is under growing pressure from other cabinet members to increase government spending further, but understandably, Tremonti keeps pointing to Italy’s huge public debt as a major impediment to any serious stimulus plan. So it is simply a question of grin and bear it.<br /><br />Tremonti admitted at a recent meeting with banks, companies and unions that Italy had seen a greater credit market conditions tightening in recent months than most other eurozone economies. On the other hand he pointed to the fact that Italian banks had shown a “strong interest” in taking up the government-backed bond offer (which only totals €12bn) at the same time as he rejected criticism that the 8.5 per cent interest rate they carry was too high.<br /><br />Intesa Sanpaolo, which is Italy’s biggest bank by market value, has announced that it will apply for 4 billion euros worth of the bonds after it posted a 1.23 billion-euro fourth-quarter loss on writedowns. This makes Intesa the third Italian lender to take advantage of the country’s bank aid package, following similar decisions by Banco Popolare and UniCredit.<br /><br />At the same time the credit crunch is evidently producing some sort of housing crisis and the sale of residential properties dropped 15 percent last year, according to OMISE, a government agency that specializes in collecting data on real estate. Property specialists Nomisma forecast house prices will fall 8.5 percent in the second half of 2009, and for a country which has not seen much of a housing boom, this drop is significant. Italian Prime Minister Silvio Berlusconi has announced a housing plan designed to make it easier for property owners to carry out home modernisation. According to Il Sole, Italians will be able to add as much as 20 percent of the current size of their homes without planning formalities. This is obviously rather controversial, and Bank of Italy Governor Mario Draghi was himself pretty non commital in his testimony before a parliamentary commission last week, resticting himself to saying that the “plan could act as a stimulus, although the short-term effect on economic growth is uncertain.”</p>Unknownnoreply@blogger.com4tag:blogger.com,1999:blog-3949752.post-42239767761387807432009-03-22T10:50:00.001+01:002009-03-22T11:00:24.235+01:00The Almunia Syllogism<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEivCgRHuAgs-R20SuF8FdxC2MFpUU0qjg5xCXw3nL-yy-pMo8bRe-enu4XxiPYVFKPYr7MQUSxvUWPR9py6sI0ZrN4_CcRd2xninLEW4lCc0OZR9lLReiBm22vnSS9k1KThSV6ljQ/s1600-h/almunia.png"><img id="BLOGGER_PHOTO_ID_5311981411101868642" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 230px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEivCgRHuAgs-R20SuF8FdxC2MFpUU0qjg5xCXw3nL-yy-pMo8bRe-enu4XxiPYVFKPYr7MQUSxvUWPR9py6sI0ZrN4_CcRd2xninLEW4lCc0OZR9lLReiBm22vnSS9k1KThSV6ljQ/s400/almunia.png" border="0" /></a><br /><br />European Monetary Affairs Commissioner Joaquín Almunia recently, and possibly totally inadvertently, <a href="http://www.reuters.com/article/ousiv/idUSTRE5222QP20090303">stumbled on a very interesting argument</a>. Here it is:<br /><blockquote>"Who is crazy enough to leave the euro area? Nobody," Almunia said. "The number of candidates to join the euro area increases. The number of candidates to leave the euro area is zero."</blockquote><br /><br /><strong>Reductio Ad Absurdum</strong><br /><br />Now you don't need a PhD in economics to understand what follows, although a little bit of basic logic would help. What we have here could be construed as a kind of syllogism (and from now on let's christen this one "The Almunia Syllogism"). The Almunia Syllogism has the following form:<br /><br />a) Anyone leaving (or aiding and abetting the departure of someone from) the Eurozone is crazy<br />b) The EU Commission, The ECB and The National Leaders are not crazy<br />c) Therefore no one will leave, or be allowed to leave, the eurozone (at least under current conditions)<br /><br />Q.E.D. We Will Have A United States Of Europe.<br /><br />Well, ok, I do need to add a lettle lemma here to the effect that the only way to enforce (c) is to build the necessary architecture, and there is room for debate about this, since this lemma is neither proven, nor is it self evident. You also need to accept that there is an excluded middle here, and we do not have a "now either the EU leaders are crazy ot they aren't" fork which we can get diverted down.<br /><br />As I say, the lemma is not self evident, although my own opinion is that in the weeks and months to come its validity will become extraordinarily clear even to the most reticent among us, but this still needs to be established. The thing about the lemma is that it focuses the debate. Those who do not agree with it need to be able to show how we can have (c) within the present architecture (since here there is a middle to exclude, either we can or we can't). The results coming out from the "we can" camp are not entirely encouraging. For example, ECB Executive Board member Lorenzo Bini Smaghi's recent attempt to argue that Krugman has it wrong, and that (<a href="http://blogs.wsj.com/economics/2009/03/19/ecb-official-responds-to-krugman-criticism/">we can manage with what we have</a>) fails stupendously to convince, in my opinion, and especially the extract I reproduce below (which exemplifies precisely the point those who want new achitecture are making).<br /><br /><blockquote>For instance, for the period 2009-10, discretionary measures adopted in Germany total 3.5% of GDP, compared with 3.8%in the United States. In some European countries, such as Italy, the size of such stimulus measures is relatively limited owing to the high levels of debt, but in other countries the total fiscal stimulus is larger than in the United States.</blockquote><br />The whole issue is that we need a mechanism to average out the stimulus, is that so hard to understand? Is this obscurantism, or simply stupidity?<br /><br /><strong>A Literary Trope Not A Syllogism</strong><br /><br />On the other hand, the formal validity of the following "utterance" from Almunia is rather more questionable.<br /><br /><blockquote>"Don't fear for this moment," he said. "We are equipped intellectually, politically and economically to face this crisis scenario. But by definition these kinds of things should not be explained in public."</blockquote><br />The first phrase is an exhortation, one which I would agree with (but not for the same reasons), the second is an assertion whose truth content is, at least, questionable, while the third is an admission, one which would perhaps better not have been made, or a piece of advice, which the unfortunate Otto Bernhardt <a href="Otto Bernhardt">seems never to have received</a>. <br /><blockquote>A senior German lawmaker said euro zone states stood ready to come to the aid of financially fragile members of the currency bloc, sparking furious denials from European leaders that a specific rescue plan existed. Otto Bernhardt, a leading lawmaker in Angela Merkel's Christian Democrats (CDU), told Reuters in an interview late on Thursday: "There is a plan."</blockquote><br />and <a href="http://www.bloomberg.com/apps/news?pid=20601100&sid=acd_L3f3h7Uk&refer=germany">then Bloomberg let us know a bit more about the details of the plan</a>.<br /><blockquote>The German Finance Ministry has no knowledge of a rescue fund organized by the European Central Bank for troubled euro-region members such as Ireland and Greece, spokeswoman Jeanette Schwamberger said. <br /><br />Otto Bernhardt, finance spokesman for Chancellor Angela Merkel’s Christian Democratic Union, said in an interview with Reuters today that the ECB has a fund at its disposal to help troubled countries and can make money available at 24 hours’ notice. </blockquote>Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-3949752.post-55501138844965075742009-03-18T15:17:00.000+01:002009-03-18T15:18:18.260+01:00Here We Go Time Gets Near With UnicreditI have been warning on the parlous position of Italy's Unicredit for some time now (see <a href="http://italyeconomicinfo.blogspot.com/2009/02/italy-needs-eu-bonds-and-it-needs-them.html">this initial EU Bonds post</a>, or the earlier history of the Unicredit problem, <a href="http://italyeconomicinfo.blogspot.com/2008/12/unicredit-shares-fall-again-merrill.html">here</a>, <a href="http://italyeconomicinfo.blogspot.com/2008/10/unicredit-stays-in-news.html">here</a>, <a href="http://italyeconomicinfo.blogspot.com/2008/10/colonialism-goes-into-reverse-gear-as.html">here</a>, <a href="http://italyeconomicinfo.blogspot.com/2008/10/against-all-adversity-unicredit.html">here</a>, <a href="http://italyeconomicinfo.blogspot.com/2008/11/unicredit-has-not-made-losses-on.html">here</a>). Well, today the story took another turn for the worse.<br /><br />It all started yesterday, when <a href="http://www.bloomberg.com/apps/news?pid=newsarchive&sid=axnWT0g6ZeRg">Bloomberg came in with a report</a> about Unicredit's eastern exposure, outlining how a decade long expanison, which saw more than $65 billion of acquisitions in operations stretching from Poland to Kazakhstan is now alarming analysts who forecast that loan defaults in eastern Europe, where the bank focused its growth, are set to balloon. Unicredit's stock is down 76 percent in the past 12 months, the second-biggest decline among Italian banks. <br /><br /><blockquote>“Eastern Europe is the new bogeyman,” said Massimiliano Romano, an analyst at Concentric Italy in Milan. “UniCredit has subsidiaries in 17 different countries there. We used to see that as diversification, now we see it as a risk.” </blockquote><br /><br />Then came the news, again yesterday, that the bank had suffered a 57 percent decline in fourth-quarter profit. Finally, this morning, the bank informed us that they are planning to ask for as much as 4 billion euros in government aid. In fact the profit results were not as bad as some analysts had been forecasting, but then these results are for 2008, which, as the company said in its statement, was still a “very good year” in eastern Europe. 2009 looks set to be quite a lot worse, and 2010? As Unicredit CEO Alessandro Profumo said, the bank is "monitoring countries including Ukraine very closely". <br /><br />In fact the bank is going to apply for aid in both Austria and Italy, and this is not surprising since according to a statement from the Bank of Italy earlier this week, <a href="http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aXxFzEH_all8">Italy's national debt climbed to 105.8 percent of gross domestic product at the end of last year</a>, up from 103.5 in December 2007. So the credit rating agencies' patience is already being badly strained, even if the quality of their mercy might not be.<br /><br />Oh, and just to cap it all, and a very bad day for Unicredit, HVB Group, their German banking unit, announced this morning that they had a loss of 671 million euros last year because of writedowns on investments and higher provisions for risky loans. HVB’s trading results were “severely affected by the extreme market turmoil which intensified in the fourth quarter of 2008,” according to the company statement.<br /><br />Basically, this is that well known proverbial situation, where Europe's leaders twiddle their thumbs, while Rome, almost literally, burns.Unknownnoreply@blogger.com5tag:blogger.com,1999:blog-3949752.post-78542457518763266722009-03-03T09:32:00.000+01:002009-03-03T09:37:51.599+01:00Eurozone Inflation Expectations Fall As The Output Gap Rises<blockquote>It’s a depressing spectacle: on both sides of the Atlantic, policy-makers just keep falling short — and the odds that this slump really will turn into Great Depression II keep rising.<br /><br />In Europe, leaders rejected pleas for a comprehensive rescue plan for troubled East European economies, promising instead to provide “case-by-case” support. That means a slow dribble of funds, with no chance of reversing the downward spiral.<br /><br />Oh, and Jean-Claude Trichet says that there is no deflation threat in Europe. What’s the weather like on his planet?<br /><a href="http://krugman.blogs.nytimes.com/2009/03/02/failing-the-test/">Paul Krugman, yesterday</a></blockquote><br /><br />What follows here are simply a few charts to illustrate further <a href="http://fistfulofeuros.net/afoe/economics-and-demography/there-is-no-deflation-threat-in-europe-jean-claude-trichet-oh-really/">the argument I developed yesterday</a> as regards the significance of the deflation threat which now exists in the eurozone. The argument is that the ECB is once again being far too cautious, and risks allowing the entire eurozone to entire a deflationary cycle which may prove to be a lot harder to get out of than it was to get into. In my view the ECB should bring the refinancing rate close to zero % at next Thursday's rate setting meeting, and then explore what measures can be taken to introduce a zonewide version of US/Japan style Quantitative Easing as quickly as possible.<br /><br />The key argument I am presenting is that it is a mistake to focus at this point on what is happening to energy, food and other commodity prices. The key issue is what is happening to core prices, and what will continue to happen to them as output contracts further. The other side of the coin are inflation expectations, and as we will see below these are now falling rapidly across Europe. It is very important at this point that these expectations do not get "locked in" to price fall expectations.<br /><br />It is evident that the degree of economic slack in the OECD is now widening rapdily as unemployment rises and capacity utilization falls. The OECD output gap (the difference between current levels of output and some estimate of what "capacity" output could be at this point) continues to widen and is now only second in importance to the output gap seen in the early 1980s. In fact, the output gap is likely to have widened further since the OECD last made its forecasts in November 2008 (the OECD leading indicator has, for example, continued to decline since that point) but the output gaps shown for the US, the UK and eurozone in the chart below are already sufficiently pronounced to make the point quite clearly I think.<br /><br /><br /><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjSqfesXwaFfrMp0IlHsAHXXnrjyKxkorfd-TnRrsedpF_9w8CltIo9wA0XDjIESSuuB4ixAXWxk6PMTmIF-Rx2e8dFneFlcZgWZSToGFy2BWCjw0j24cqscPk4e4UbpN-vitdqqQ/s1600-h/oecd+output+gap.png"><img id="BLOGGER_PHOTO_ID_5308863735440575314" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 255px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjSqfesXwaFfrMp0IlHsAHXXnrjyKxkorfd-TnRrsedpF_9w8CltIo9wA0XDjIESSuuB4ixAXWxk6PMTmIF-Rx2e8dFneFlcZgWZSToGFy2BWCjw0j24cqscPk4e4UbpN-vitdqqQ/s400/oecd+output+gap.png" border="0" /></a><br />In fact, spare capacity is a phenomenon which extends way beyond the OECD, and economies throughout the world are operating at below their potential and look set to do so for both the remainder of this year and most of 2010. Global manufacturing has been contracting and global trade has collapsed. Here is the latest JP Morgan Global Manufacturing PMI.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh3TOBCgu3WqbOzO2GaBLn98vPFvIVA3ljCBlZGzow2L330j2vUclMlZvFWhit-PstsBLb1156LNq-BMZuty7CMT58FMNnvzyZgVgCqJXEY2I4TlPw1ZI23FoEaqeYh9UDdlwcmxg/s1600-h/global+pmi.png"><img id="BLOGGER_PHOTO_ID_5308651429277926002" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 228px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh3TOBCgu3WqbOzO2GaBLn98vPFvIVA3ljCBlZGzow2L330j2vUclMlZvFWhit-PstsBLb1156LNq-BMZuty7CMT58FMNnvzyZgVgCqJXEY2I4TlPw1ZI23FoEaqeYh9UDdlwcmxg/s400/global+pmi.png" border="0" /></a><br /><br /><br />The IMF currently estimates that the cumulative global output loss relative to potential over the period 2008-2010 will be as much as 5% (see chart below).<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiFCjYfee7UarAV2PZHE2s4o5AsbNYV9nakBD96t91UCeY8Agou6DCbF-PeAG0wdcPMEktd_b1PAIpngWh9O7tBL47yl-pXMuC_magECBX0L_HSln7jep3HC09LFROC0L6ldcmFsw/s1600-h/IMF+output+loss.png"><img id="BLOGGER_PHOTO_ID_5308865291474469074" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 255px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiFCjYfee7UarAV2PZHE2s4o5AsbNYV9nakBD96t91UCeY8Agou6DCbF-PeAG0wdcPMEktd_b1PAIpngWh9O7tBL47yl-pXMuC_magECBX0L_HSln7jep3HC09LFROC0L6ldcmFsw/s400/IMF+output+loss.png" border="0" /></a><br />And inflation expectations are falling rapidly. The latest findings in the European Commission’s own consumer questionnaire show that the net balance of respondents in the UK and the Euro zone expecting prices to be higher this time next year is now at the lowest recorded level - just 2.7% and 4.1% respectively ( see chart below).<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEin4DNZK_12x3YSSxW2qAxtEalqdNcHtnH5xV3grsZxn7rzG_T1GCG5axgSQhXMGyMnKiwv0a2PWG8LV93Fj5LATIM1oOV2rtJy2ZshDaJUd9JjU6ipDVtmeZwQq6MeJD7VSBZffg/s1600-h/eu+inflation+survey.png"><img id="BLOGGER_PHOTO_ID_5308866015874145522" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 253px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEin4DNZK_12x3YSSxW2qAxtEalqdNcHtnH5xV3grsZxn7rzG_T1GCG5axgSQhXMGyMnKiwv0a2PWG8LV93Fj5LATIM1oOV2rtJy2ZshDaJUd9JjU6ipDVtmeZwQq6MeJD7VSBZffg/s400/eu+inflation+survey.png" border="0" /></a><br /></p>Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-3949752.post-41242269187605707742009-03-02T13:52:00.000+01:002009-03-02T13:58:52.851+01:00"There Is No Deflation Threat In Europe" - Jean Claude Trichet - Oh Really!He's at it again. Last year he was busily trying to worry us all that inflation was set to get completely out of hand among the 16 countries who make up the eurozone. Now the President of the European Central Bank, Jean-Claude Trichet, is hard at it on another tack and <a href="http://www.reuters.com/article/bondsNews/idUSLL48440320090121?sp=true">is busying himself trying to convince us</a> that there is no credible deflation threat facing these countries. Apart from getting it wrong on both occasions, the common point here would be a certain inbuilt "inflation bias", a bias which was earlier called "the original sin of the Bundesbank" by nobel prize winning Italian economist Franco Modigliani.<br /><br /><blockquote>"There is presently no threat of deflation," Trichet told a committee of the European Parliament on Wednesday 14 February. "We are currently witnessing is a process of disinflation, driven in particular by a sharp decline in commodity prices." ..."It is a welcome development," he said, adding that the fall in energy, and other prices should help boost struggling economies.</blockquote>Apart from manifesting a spectacular lack of economic judgement, the Financial Times's Banker of the Year 2007 is now forcing us to ask the embarassing question as to just how far "out of touch" you can get with the material you are supposed to be handling and continue to hold down your job. It seems we are forced to come up with the rather worrying response, that, in the case of the principal EU institutions (remember <a href="http://fistfulofeuros.net/afoe/economics-and-demography/putting-out-fires-during-noahs-flood-or-eyeless-in-gaza-part-ii/">the sad case of Economy and Finance Commissioner Joaquin Almunia</a>), the answer is "bastante" (consideably), since a quick look at the data we have to hand shows us that Eurozone inflation is already significantly undershooting the European Central Bank’s own target (and principle policy objective) of maintaining the annual rate “below but close” to 2%. Worse, by all appearances the rate of consumer price inflation in the eurozone is now set to head straight off into negative territory.<br /><br />If we look at headline HICP inflation on an annualised basis, we will find that it fell more than expected in January - to 1.1 per cent, according to Eurostat data - down quite dramatically from the peak of 2.7 per cent hit in March last year. This was the lowest level we have seen since July 1999, and a sharp drop from the 1.6 percent rate registered in December. On a month-to-month basis, prices were down 0.8 percent. The "core" inflation rate - that is consumer inflation without the volatile elements of food, energy, alcohol and tobacco - we find it still stood at 1.6%, since the biggest impact on headline inflation comes from the decline in food and energy costs. But if we look at the monthly movement in the core index, we find that it dropped by a very large 1.3% (see chart below).<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjWpaWcv00zbneVAUip_cnhs6XE-3-aTS2D6TIo-aEtbSYrFXJepFe59UETrO_rWmkjaNvNAr-JRq_HOqv5nKGqOaOQ8wEQTEsV18G2YaYKtw8_f-5HB1OqaA55v4cV6un2LiWRTg/s1600-h/eurozone+hicp.png"><img id="BLOGGER_PHOTO_ID_5308138047370302626" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 221px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjWpaWcv00zbneVAUip_cnhs6XE-3-aTS2D6TIo-aEtbSYrFXJepFe59UETrO_rWmkjaNvNAr-JRq_HOqv5nKGqOaOQ8wEQTEsV18G2YaYKtw8_f-5HB1OqaA55v4cV6un2LiWRTg/s400/eurozone+hicp.png" border="0" /></a><br /><br />Now if we come to look at the core inflation rate over the last six months, we find that the index has only risen 0.1% (or an annual rate of 0.2%). This gives us a much more accurate reading on where inflation actually is at this point in time, and where it is headed. The chart below shows the six month lagged annualised rate for the last twelve months, and the sharp drop in January is evident. If things continue like this, then the eurozone as a whole is headed straight into deflation, for sure.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjYgq-0zlGoseb74tRx2zQ1JMXoAligawrQAC734AqgAELX9P9-0OYklOH6qhEYETYfeaw1BdNAG-OevPs4v23CDflatj2ohyP1ueMDxUN2zWn6fdF5uxsrsQtte4qMTs8s33Fdzg/s1600-h/eurozone+6+months.png"><img id="BLOGGER_PHOTO_ID_5308137923013696194" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 222px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjYgq-0zlGoseb74tRx2zQ1JMXoAligawrQAC734AqgAELX9P9-0OYklOH6qhEYETYfeaw1BdNAG-OevPs4v23CDflatj2ohyP1ueMDxUN2zWn6fdF5uxsrsQtte4qMTs8s33Fdzg/s400/eurozone+6+months.png" border="0" /></a><br /><br /><strong>Why Should Prices Continue to Fall?</strong><br /><br />So what are the grounds for thinking that inflation may be now heading into negative territory (ie that we are entering deflation right now), despite the fact that the ECB revised forecast is likely to come out at about 0.7 per cent this year and 1.5 per cent in 2010, according to estimates from Julian Callow, European economist at Barclays Capital. Well let's look at a chart produced by Paul Krugman showing the relation between the US output gap and the inflation rate.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg5PXyufO5WvmagjDdAMZLCaiZnS0FvbXTCtDG-5fQ4E_x5ekMrXTano72wncKvX765Zu1Llel6HTm9PA42Yw_TVu516qmwamUgGCqoqth4c90iDmMa9liG3zmAyZ7B0PFS7hM-Rw/s1600-h/output+gap.png"><img id="BLOGGER_PHOTO_ID_5308122533544135058" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 348px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg5PXyufO5WvmagjDdAMZLCaiZnS0FvbXTCtDG-5fQ4E_x5ekMrXTano72wncKvX765Zu1Llel6HTm9PA42Yw_TVu516qmwamUgGCqoqth4c90iDmMa9liG3zmAyZ7B0PFS7hM-Rw/s400/output+gap.png" border="0" /></a><br /><br />Now as <a href="http://krugman.blogs.nytimes.com/2009/02/04/about-that-deflation-risk/">Krugman explains</a> the figure plots an estimate of the output gap — the difference between actual and potential GDP, as a percentage of potential — and the change in the inflation rate. (Both series are taken from the IMF WEO database, for convenience, and use data from 1980-2007).<br /><br />The fit, as he says, is not perfect, but the correlation is evident, and there is an implied slope of about 0.5 — that is, every percentage point by which real US GDP fall short of potential tends to reduce the inflation rate by about half a point over the course of the year. Now I am not going to advance here estimates of the present output gap in the eurozone, but we do have clear indications of a sharp and ongoing contraction in demand in the GDP numbers. Eurozone GDP contracted by 0.2% between the second and the third quarters of last year, and by 1.5% between the third and fourth quarters.<br /><br />What's more the key indicators suggest that the contraction is accelerating at this point. The February Markit euro-zone composite PMI reading dropped to a record low of 36.2 from 38.3 in January. Any reading below 50 on these indexes indicates month on month contraction.<br /><br /><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhv1z7mWsmJ5nChL848pevIfblAje398Qxmu4oaZR8VEyB7X248QctLeq1jOFCQbTFqMmlaJUsSDoVVzcEFZRr0In9PILdMwCdl6UrF6tbcqqYoDfHjy_uYsh139kB9ZS2lLUnj2g/s1600-h/eurozone+composite.png"><img id="BLOGGER_PHOTO_ID_5304856416281100146" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 228px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhv1z7mWsmJ5nChL848pevIfblAje398Qxmu4oaZR8VEyB7X248QctLeq1jOFCQbTFqMmlaJUsSDoVVzcEFZRr0In9PILdMwCdl6UrF6tbcqqYoDfHjy_uYsh139kB9ZS2lLUnj2g/s400/eurozone+composite.png" border="0" /></a><br /><br />Barring some spectacular (and entirely improbable) turnaround in March it now seems likely that the Q1 GDP contraction will be worse than the Q4 2008 one, and considering (as mentioned previously) that the eurozone contracted by 0.2% in Q3 2008, and by 1.5% in Q4, then, in my humble opinion, the data we are seeing for this quarter are entirely consistent with a 2% quarterly contraction (or an annualised 8% rate of contraction). For those of you who simply don't believe that PMIs can tell you so much, take a look at Markit's own chart (below), showing the strong underlying relationship between movements in GDP and the *flash* composite PMI. The results they achieve are pretty impressive I would say.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiPYmeawVtyVGqRquM9wyqCuYhDFC1-vZXH3KAVXHSxzrMAOEBVYD1ThHbfgI1oxz9xZCr9oiz0bPWSZWWY7geoQSR87SQA6frBbtSpTYdLY5tk8D-bIPgxlhTn8l4_uaAk4PphMQ/s1600-h/euro+composite+GDP.png"><img id="BLOGGER_PHOTO_ID_5304859097174071490" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 254px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiPYmeawVtyVGqRquM9wyqCuYhDFC1-vZXH3KAVXHSxzrMAOEBVYD1ThHbfgI1oxz9xZCr9oiz0bPWSZWWY7geoQSR87SQA6frBbtSpTYdLY5tk8D-bIPgxlhTn8l4_uaAk4PphMQ/s400/euro+composite+GDP.png" border="0" /></a></p><br /><br />and if we look at an additional indicator (the EU's own Economic Sentiment Indicator for the eurozone) we will see that it hit yet another low in February (see below) which again suggests that the contraction is accelerating at this point, and substantially so.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhcSk7FNd96KhM0WKAdRKTSP1oNRy8GD4Phag5Hta8nCt5iLAHHdpiATcHXPhifn5SqGS1ng2neklifAAKPg0MtEh2C0BTJA_Td9Z9LQYiDFtHaH4sJnY59JR3lQuMdDBeBsFAfVQ/s1600-h/eurozone+confidence+index.png"><img id="BLOGGER_PHOTO_ID_5308137981124240434" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 234px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhcSk7FNd96KhM0WKAdRKTSP1oNRy8GD4Phag5Hta8nCt5iLAHHdpiATcHXPhifn5SqGS1ng2neklifAAKPg0MtEh2C0BTJA_Td9Z9LQYiDFtHaH4sJnY59JR3lQuMdDBeBsFAfVQ/s400/eurozone+confidence+index.png" border="0" /></a><br /><br />So the core HICP index is on the point of turning negative on a six monthly basis, and the situation appears set to get even worse, and our Central Bank President assures us that "there is presently no threat of deflation". So which world am I living in, or which is he?<br /><br />There are further reasons to anticipate a sharp downward pull on prices from some countries in the zone (like Spain and Ireland), since they have housing and construction booms which are in the process of unwinding, and the only way they can recover the competitiveness they have lost is by conducting a sharp and significant downward revision in prices and wages (since in a currency union there is effectively no currency to devalue). The two charts below show the loss of competitiveness experienced by the Irish and the Spanish economies (respectively) with regards to the German economy since 1999 as measured by real effective exchange rates (REERs).<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjEozrZPQPMThh_9pwiWurnMljO9ceS2nxDcOIN3VJ0INJCFFFuyQcwuDc_s9oazJJ4FoL_nUMqD69fbkGTbob4FRh8F_2UOskZ8QVygU-55ZthnqHA6Jkcu7pUpRSqCX6KmxBvow/s1600-h/spain+and+Germany.png"><img id="BLOGGER_PHOTO_ID_5308138269766091170" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 217px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjEozrZPQPMThh_9pwiWurnMljO9ceS2nxDcOIN3VJ0INJCFFFuyQcwuDc_s9oazJJ4FoL_nUMqD69fbkGTbob4FRh8F_2UOskZ8QVygU-55ZthnqHA6Jkcu7pUpRSqCX6KmxBvow/s400/spain+and+Germany.png" border="0" /></a><br /><br />REERs attempt to assess a country's price or cost competitiveness relative to its principal competitors in international markets. Since changes in cost and price competitiveness depend not only on exchange rate movements but also on cost and price trends the specific REERs used by Eurostat for its Sustainable Development Indicators are deflated by nominal unit labour costs (total economy) against a panel of 36 countries (= EU27 + 9 other industrial countries: Australia, Canada, United States, Japan, Norway, New Zealand, Mexico, Switzerland, and Turkey). Double export weights are used to calculate REERs, reflecting not only competition in the home markets of the various competitors, but also competition in export markets elsewhere. A rise in the index means a loss of competitiveness.<br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiWMxqeXpGPt6xdTqHF2reAqyEGd_nTTMf8odlrGt5Vxcntt8687jaDKVuUyoqn9QB9qNuAyqB-3D7ngTLl0Ie2yZMJl7ML6o_gxFlEE29GRaOklelzYLcm1PXENOzO1pk4JqQfGQ/s1600-h/germany+and+ireland.png"><img id="BLOGGER_PHOTO_ID_5308138113517224546" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 216px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiWMxqeXpGPt6xdTqHF2reAqyEGd_nTTMf8odlrGt5Vxcntt8687jaDKVuUyoqn9QB9qNuAyqB-3D7ngTLl0Ie2yZMJl7ML6o_gxFlEE29GRaOklelzYLcm1PXENOzO1pk4JqQfGQ/s400/germany+and+ireland.png" border="0" /></a><br />Now the eurozone being a common currency area presents us with specific problems in the context of deflation since, as the Irish economist <a href="http://www.irisheconomy.ie/index.php/2009/02/05/deflation-and-competitiveness/">Philip Lane argues</a> a member of a currency union comes up against a natural limit in national-level deflation. Thus, he argues, while a country like Ireland may well face a sustained period of inflation below the euro area average (such that it may be negative in absolute terms for a greater or lesser period of time), the situation should tend to be self-correcting since the deflation implies an improvement in competitiveness, which should generate a boost in export driven economic activity and, over time, a return to an inflation rate at around the euro area average. I'm not sure that this argument is 100% valid, since sufficient internal demand lead deflation can so effect household and corporate solvency that debt deflation can at the very least send a country off into a sizeable and significant correction (say a decade long one) before the price level falls sufficiently to generate sufficient export activity to offset the decline in domestic demand and enable balance sheets to recover. But going into all this would get pretty wonkish, so, leaving that rather theoretical point aside, lets think about a more rather concrete and immediate reason for worrying about what is happening at the present time in the eurozone, and that is the possibility that the inflation and competitiveness benchmark country, in this case Germany, may itself be about to experience an internal price deflation process which is every bit as sharp as the fall in prices which is taking place in those economies which are supposed to be correcting vis-a-vis Germany itself. That is, let's consider the possibility that through this mechanism the deflation may become eurozone wide, and relatively self perpetuating, if something is not done to break the cycle.<br /><br />So, if we now go on to look at the two relevant charts below (for Spain and Ireland) we will find that in each case core indexes are falling more or less in line with the German one. In fact, both the Spanish and the German indexes are unchanged over the last six months, the Irish one is down 0.5%. At this pace (a 1% a year differential with Germany) Ireland would recover its 1999 comparative position vis-a-vis Germany in around 30 years, a rather lengthy process to say the least.<br /><br />But the point here is not that prices are falling in Ireland and Spain (they have to do this) but that prices are also set to fall in Germany, and this is where monetary policy from the ECB becomes vital, since if Germany is allowed to fall into deflation then it will be extremely difficult for Spain and Ireland to "correct" (the drop in wages and prices would have to be sharp indeed) but also monetary policy from the ECB would be in danger of becoming a complete mess.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjdS_mFMPHXVkR5e_Lyw8w7sXiIr8s_3mOQhQ2aoMkIzfLfxKEPmC6UbRSRyPwBEmfFBL-sUuG584sUBlwhkOxTKBFfDU0NycXmyGWF6o39sydI8wrrliVfFxbYnS6Gm7IKTgHHZQ/s1600-h/spain+and+Germany+HICP.png"><img id="BLOGGER_PHOTO_ID_5308138324286072002" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 221px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjdS_mFMPHXVkR5e_Lyw8w7sXiIr8s_3mOQhQ2aoMkIzfLfxKEPmC6UbRSRyPwBEmfFBL-sUuG584sUBlwhkOxTKBFfDU0NycXmyGWF6o39sydI8wrrliVfFxbYnS6Gm7IKTgHHZQ/s400/spain+and+Germany+HICP.png" border="0" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjQRAUZB3OjIpsh4gYcj-huncTJt1699gWaNuFgYta1kLQQFSwGxWz8-DS2hMCs_80BEpRPaTYzG7d77bFTMRfYtsBV2Cx8FtOkWLN7y58QIjW8VmPzDUMOUZjtnyFFZTC2T0RR6A/s1600-h/ireland+and+germany+hicp.png"><img id="BLOGGER_PHOTO_ID_5308138193609955522" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 221px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjQRAUZB3OjIpsh4gYcj-huncTJt1699gWaNuFgYta1kLQQFSwGxWz8-DS2hMCs_80BEpRPaTYzG7d77bFTMRfYtsBV2Cx8FtOkWLN7y58QIjW8VmPzDUMOUZjtnyFFZTC2T0RR6A/s400/ireland+and+germany+hicp.png" border="0" /></a><br /><br />Of course not everyone on the ECB governing council shares Trichet's rosier-than-rosy view, and in a comment that offered an insight into how at least some ECB council members are thinking, Mario Draghi, Italy’s Central Bank Governor said recently that “the governing council is keeping a close watch on the real cost of money”. What he means is that, if Spain's 1.5% drop in core prices over the last three months turned into a 6% annual drop, then the real rate of interest currently being applied would be around 8%, which would constitute a very tight monetary policy in the context of Spain's worst recession in living memory.<br /><br />Perhaps some readers may feel I have been unduly hard on Jean Claude Trichet in this post, but I would simply close by reminding everyone of the conclusions reached in a once widely quoted paper - <a href="http://econpapers.repec.org/paper/fipfedgif/729.htm">Preventing deflation: lessons from Japan's experience in the 1990s</a>, by Alan Ahearne, Joseph Gagnon, Jane Haltmaier and Steve Kamin (2002) - where the authors argued:<br /><br /><blockquote>We conclude that Japan's sustained deflationary slump was very much unanticipated by Japanese policymakers and observers alike, and that this was a key factor in the authorities' failure to provide sufficient stimulus to maintain growth and positive inflation. Once inflation turned negative and short-term interest rates approached the zero-lower-bound, it became much more difficult for monetary policy to reactivate the economy. We found little compelling evidence that in the lead up to deflation in the first half of the 1990s, the ability of either monetary or fiscal policy to help support the economy fell off significantly. Based on all these considerations, we draw the general lesson from Japan's experience that when inflation and interest rates have fallen close to zero, and the risk of deflation is high, stimulus, both monetary and fiscal, should go beyond the levels conventionally implied by baseline forecasts of future inflation and economic activity.</blockquote><br /><br />As some economist or other I read is in the habit of saying "history has a nasty habit of repeating itself, the first time as tragedy and the second time as tragedy". Or put another way, here we go again. Hello, is there anyone out there?Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-3949752.post-63989309243073690712009-02-26T16:44:00.005+01:002009-02-27T00:07:13.494+01:00Business Confidence and Retail Sales Fall and FallItalian business confidence fell to a record low in February as concern that the fourth recession in seven years will damp orders more than offset lower oil prices and borrowing costs. The Isae Institute’s business confidence index dropped to 63.2, the lowest since the index was created in 1986, from a revised 65.4 in January.<br /><br /><br /><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEizRjq1H8-4GiVaG5LTq3xjFQ5tez-4lP6RfKOeBxFW_qXVSdOaWlt0rOXPrSnVRVJhHjPB_9gr44tEcRgEZ4GekwAZAHbTxd0iBKA_vcvZ2vEkKrpwM1eg6K6-tHsb-zHeLS9rVw/s1600-h/italian+business+confidence.png"><img id="BLOGGER_PHOTO_ID_5307132477866387746" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 190px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEizRjq1H8-4GiVaG5LTq3xjFQ5tez-4lP6RfKOeBxFW_qXVSdOaWlt0rOXPrSnVRVJhHjPB_9gr44tEcRgEZ4GekwAZAHbTxd0iBKA_vcvZ2vEkKrpwM1eg6K6-tHsb-zHeLS9rVw/s400/italian+business+confidence.png" border="0" /></a><br /><br />Italian executives also reported having more problems getting credit in February. The report showed that 40.2 percent of those surveyed said the credit situation worsened, up from 33.5 percent in January. The new orders sub component also fell, to minus 65 from minus 58 in January, the lowest since 1991. And manufacturers’ expectations for production over the next three months fell to minus 24 from minus 20.<br /><br /><strong>Retail Sales Fall</strong></p><p>Italian retail sales contracted for the 24th consecutive month in February as the credit crunch tightened its grip on spending, and consumers put off purchases of cars and home appliances.<br /><br /></p><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh2L7qYBk-DQzJHl6f-jztThuDgxkbsDEJzwGtLzGs86p7y1mWyxv-lzaneffgBVnSGWHSGyZIn4PvHoAfZPtM1sDV3uUTUanuSr_7zuHAACpzpGzn7XOj9Bpl8oeVfLDNcQVS-Pw/s1600-h/Italy+retail+PMI.png"><img id="BLOGGER_PHOTO_ID_5307134583462104482" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 205px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh2L7qYBk-DQzJHl6f-jztThuDgxkbsDEJzwGtLzGs86p7y1mWyxv-lzaneffgBVnSGWHSGyZIn4PvHoAfZPtM1sDV3uUTUanuSr_7zuHAACpzpGzn7XOj9Bpl8oeVfLDNcQVS-Pw/s400/Italy+retail+PMI.png" border="0" /></a><br /><br />Italy's entered its fourth recession in seven years in the third quarter of 2008. The Italian government now forecasts the economy will contract 2 percent this year, the second consecutive year of contraction, and even this seems optimistic at this point. The government has announced an 80 billion-euro stimulus plan and 2 billion euros in incentives for the purchase of cars and home appliances., but in general the country is too indebted to be able to do anything very ambitious.</p><p>So Italy waits, in the hope that help may come from Brussels, where the 27 members of the EU will meet on Sunday - <a href="http://fistfulofeuros.net/afoe/economics-and-demography/angela-merkel-says-maybe-to-common-eu-initiative-in-support-of-member-states/">lead it seems by Angela Merkel</a> - to decide what to do next.<br /><br />And I hope you are "readying up" that rescue plan Angela, since the difference between German and Italian benchmark bond yields <a href="http://www.bloomberg.com/apps/news?pid=20601092&sid=aIZ7lN9SDBPQ&refer=italy">widened to the most in nearly 12 years today</a> as Italy sold 10 billion euros ($12.8 billion) of government securities. <br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhY0yxEqoZSB0FzZTslmfYmK-6Tvqo_66AgDfGoIDDU15fv0IrO4A7s9FCILFZiE41yJkb0R6m0IhoqyN8EvFGOgNiaHjViXtwR8XZ5KK9DNSFV6o2UrETrpGSZKXdb2B5dU2gHrg/s1600-h/italian+yields+2.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 234px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhY0yxEqoZSB0FzZTslmfYmK-6Tvqo_66AgDfGoIDDU15fv0IrO4A7s9FCILFZiE41yJkb0R6m0IhoqyN8EvFGOgNiaHjViXtwR8XZ5KK9DNSFV6o2UrETrpGSZKXdb2B5dU2gHrg/s400/italian+yields+2.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5307246185632682130" /></a><br /><br /></p><blockquote>The spread between the 10-year note yields increased as much as four basis points to 161 basis points today, the widest since May 1997, based on generic Bloomberg prices. It was at 155 basis points as of 12:05 p.m. in London. The average in the past 10 years is 31 basis points.<br /><br />Germany or the International Monetary Fund may be forced to rescue members of the euro bloc that struggle to refinance debt, former Bundesbank President Karl Otto Poehl said today.<br /><br />“The first will certainly be a small country, so that can be managed by the bigger countries or the IMF,” he said in an interview with Sky News. “There are countries in Europe which are considering the possibility to leave the eurozone. But this is practically not possible. It would be very expensive.”</blockquote>Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-3949752.post-88462877778487647632009-02-26T16:26:00.003+01:002009-02-26T16:34:36.181+01:00Creative Accounting and Italy's Growing Unemployment ProblemIt isn't only the bank bailout programme which is suffering in Italy due to lack of sovereign borrowing capacity. (<a href="http://italyeconomicinfo.blogspot.com/2009/02/italy-needs-eu-bonds-and-it-needs-them.html">See here for the full background on Unicredit and EU Bonds</a>). I couldn't help noticing <a href="http://www.bloomberg.com/apps/news?pid=20601092&sid=aOzA499ijU90&refer=italy">this piece in Bloomberg earlier in the week</a>.<br /><br /><blockquote>Italian Labor Minister Maurizio Sacconi said the government can’t provide unlimited unemployment benefits, La Stampa reported. The government is concerned about unemployment and has freed up about 8 billion euros ($10.3 billion) in regional aid that local entities can tap into, Sacconi told La Stampa in an interview. Still, “we cannot leave the taps running,” Sacconi was also cited as saying.</blockquote><br /><br />So as the recession deepens, and layoffs spread, the Italian government is obviously going to have problems keeping people afloat. Which lead me to think, maybe there are two ways to do this, the regular, and the irregular one. And maybe Italy is the ideal place for the application of rather more "unconventional tools" in fighting the crisis, especially since money for the conventional ones is beginning to run scarce.<a name='more'></a><br /><br /><strong>More Than One Way To Peel An Onion (with and without tears)</strong><br /><br /><br />First the regular way. Well, as Deutshe Bank reseracher Frank Zipfel <a href="http://www.dbresearch.com/servlet/reweb2.ReWEB;jsessionid=2558E00D01FF7DBB7DC9F5B0022C60A6.srv12-dbr-com?addmenu=false&document=PROD0000000000238186&rdLeftMargin=10&rdShowArchivedDocus=true&rwdspl=0&rwobj=ReDisplay.Start.class&rwsite=DBR_INTERNET_EN-PROD">points out in this research report</a>, Germany’s economic stimulus packages I and II contain important funding provisions for short-time work, especially to help avert redundancies. <br /><br />And as can be seen in the graph which Zipfel prepares (see below) recent data show the extent to which these measures are important in keeping unemployment down in Germany. Since the end of November 2008, the number of applications (by both individuals and companies) for funding for short-time work resulting from the economic downturn has soared, affecting above all the mechanical engineering, metal processing and car-making sectors. Even though the number of filings does not reveal how many people are actually in short-time work, the measure does offer a useful indication of how companies are using the measures. In particular the data reveal that nearly 300,000 endangered jobs will not be lost, at least for the time being.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiHCcE_oId-aX-yFTDfxxwK8QpE4AOIFZSOMOFjGbWQ6iRGYl3umiW70mVkCFLvBfmbYLAwJjJQzJywzzbh_plxRTV4vyc31j0_jvAyZF48CaCaJHiOg8PCoawzC9zAQo2rXH9Irg/s1600-h/german+short+work.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 256px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiHCcE_oId-aX-yFTDfxxwK8QpE4AOIFZSOMOFjGbWQ6iRGYl3umiW70mVkCFLvBfmbYLAwJjJQzJywzzbh_plxRTV4vyc31j0_jvAyZF48CaCaJHiOg8PCoawzC9zAQo2rXH9Irg/s400/german+short+work.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5306752279380491586" /></a><br /><br />Zipfel explains how the system works:<br /><br /><br /><br /><blockquote>Germany’s federal agency for employment (BA) will provide funding for short-time work based on business cycle or economic reasons under Section 170 of the Social Security Code (SGB III) if certain conditions are met (among other things, at least one-third of a company's staff must be affected by loan cuts of at least 10% of their monthly gross pay). If this is the case, the amount paid by the BA for each eligible employee is based on 60% (or 67% for employees with children) of the flat-rate calculation of the missing net pay. Employers continue to pay their employees but will be reimbursed by the BA. If, for instance, the hours worked in a company are reduced by half, the employee will receive only half of his/her normal pay. The BA will then pay the employee 60% of the other half of his/her wage or salary. Thanks to substantially reduced wage costs, companies can usually manage without lay-offs, which benefits both sides: employees can keep their jobs and the company its experienced staff. The reduction of working hours and disbursement of funding for short-time work are tied to certain legal provisions. Besides business cycle-induced funding for short-time work there is also seasonal funding for workers of companies in the construction sector who receive compensation for bad winter weather.</blockquote><br /><br />Now lets take a look at how things are done elsewhere. In Italy there are basically two types of unemployment benefits:<br /><br />1) The Ordinary Redundancy Fund (cassa integrazione ordinaria) which applies in case of events such as a market crisis, i.e. problems not related to particular workers or individual employers, and offers a maximum of 12 months in 2 years, and a maximum of 3 months continously.<br />2) The Extraordinary Redundancy Fund: this comes into operation when production stops completely (in the event of serious sector crisis, bankruptcy, ...), and the employer decides to ask for state support. The Fund offers up to 36 months in any 5 years period and applies only to firms with more than 15 employees.<br /><br />Now, according a recent Italian public TV programme on the misuse of Redundancy Funds in Italy, a lot of companies - especially in some areas of Southern Italy (and in Puglia in particular) - are directly cheating the state, by sending their workers home under the Redundancy Fund procedure, and then re-employing them "in an informal way" and paying them under the counter (UTC employment?). <br /><br />So, the state is paying to the workers - lets say - 600 € from the Redundancy Fund, the employer 250-300€ under the counter, and the company can keep going. In this way workers get approximately 100% of their full-time salaries, and the Italian government doesn't need to announce any special "stimulus" measures which might make ratings agencies nervous. <br /><br />According to the economist Tito Boeri, interviewed during the report:<br /><br />- the Italian underground economy is around 15-17% of the Italian GDP, 300 billion €/year. Some estimates: up to 25% of the GDP<br />- that means at least 100 billion €/year less income from taxes for the state<br />- the industries living from the underground economy are profiting from the state aid, in this way distorting the market and undermining the future of more productive companies<br />- in Italy the unemployment benefit system does not work effectively <br />- many people with a university degree and working in Italy are hiding their qualifications to get a post for which they are over-qualified <br />- growth in the Italian economy is essentially driven by growth in low-qualified jobs<br /><br />Well, as I said, there are many ways to skin a skunk, and perhaps this particular one is what Italian Finance Minister Giulio Tremonti had in mind <a href="http://fistfulofeuros.net/afem/demographics/you-are-independent-of-all-logic-giulio-tremonti/">when he recently stated</a> that that Italy may not be faring as badly as GDP figures suggest because they don’t include the so-called black economy, worth about 17 percent of overall economic output.Unknownnoreply@blogger.com0