In Lira, or in Euros?

Even if it is a debatable question whether or not the Iraq war is bogged down in a quagmire, Italy’s economy evidently is. And no-one has even gotten round to offering a plan ‘b’, not even Tony Blair himself. So the silence is deafening, and this simply leads to increased speculation. Berlusconi only pronounced publicy on the issue last Tuesday, nearly three weeks after Maroni’s referendum call. Latest on the list of those taking a long hard look is Bloomberg’s Mark Gilbert, who has dug out an old paper by legal expert on international financial systems Hal Scott.

The key points:

“Countries have kept their own payment systems, government debt instruments, central banks, and the lion’s share of their foreign-exchange reserves,” wrote Hal Scott, professor of international financial systems at Harvard Law School, in a 1998 paper. “It is almost as if the EMU countries have hedged their bets on EMU by retaining the key institutions needed to re- establish their own currency and monetary policies if need be.”

Scott’s paper, titled “When the Euro Falls Apart,” went on to ask “would foreign law, if applicable, such as the law of the U.S. or Germany, enforce the re-denomination or provide instead that the contracts must be honored in euros or are breached if not honored in euros? This is far from clear given the lack of precedents.”

As Gilbert notes:

“The thing about sovereign debt, though, is that the sovereign can do just about anything it likes on its domestic debt, because it enacts the laws that govern those securities. That’s how Russia was able to stop paying the $40 billion it owed investors in 1998, and Argentina could default on $95 billion of bonds in 2002 and settle its accounts at 25 cents on the dollar.”

Stephen King, head of global economic research at HSBC Holdings Plc in London, togave the following analysis to Bloomberg reporter Sebastian Boyd earlier this week:

“For Italy the choice is increasingly stark. The first choice would be an aggressive tightening of fiscal policy, large tax increases followed by cuts in public spending, and I don’t really see the political will for that at the moment. The second choice would be some kind of bond default. The third choice would be an implicit bond default, by creating a system under which it could leave the euro. That would be very difficult to do.”

More or less I agree with this outline. My guess is that choice one will be tried and found to fail. Maybe then some attempt will be made to have a go at number 2. This failing, as it would, we will finally get round to option three.

I watched Argentina systematically from the late 90’s on. In Argentina terms my best guess is that we are more or less in 1998 (the default came in 2001). The count down has commenced.

This entry was posted in A Fistful Of Euros, Economics: Currencies and tagged , , by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

16 thoughts on “In Lira, or in Euros?

  1. “This is far from clear given the lack of precedents”

    Don’t the various break-ups in Eastern Europe in the 1990s provide any viable precedent ?

  2. “Don’t the various break-ups in Eastern Europe in the 1990s provide any viable precedent”?

    Interesting question, I really don’t know enough about this. I’ll have to check it out a bit. Sounds of thinking noises….

  3. Not to mention the break up of the union latin currency area in the 1880s (I think).

    But yes, a little of everything will be tried.
    One common solution is to change the political system to make it easier to impose costs on unions, raise taxes etc. In the past this often involved going off democracy, but in Italy a shift to a more Gaullist political system where the President can impose their will is a possibility.

  4. There were only three break ups. One into war. One had little debt and one had nukes, a lot of valuable property and not that much debt

  5. Czechoslovak koruna has survived the Czechoslovak Federal Republic just by two months or so in 1993. Currency breakup went smoothly. No panic, no hoarding, no economic disaster.

    We have know-how since the breakup of the Austrian-Hungarian monarchy. Should the EMU follow the same path, Czechs could be invited as advisors 😉

  6. There was little private debt in koruna. Also very cash dominated economies outside of the very bid state. i don’t think you can compare Czechoslovakia with EU/Italy

  7. Berlusconi has just said he is going to ask for two to three years breathing space to get the budget back into line:

    “I will ask two to three years,” Berlusconi was quoted by the ANSA and Apcom news agencies as saying at a news conference Friday.”

    I think the ball is now going to be firmly in the Commission’s court.

  8. I don’t know if people have been reading the linked paper. It is well worth it. At the time of posting I had just browsed quickly. One of the interesting things I hadn’t thought of is the problem of the knock-on consequences of capital flight within the eurozone.

    So lets talk this one through. Any hint that Italy (and curiously every example used by Scott – writing back in 1998 – relates to Italy) would have a two tier currency or similar would immediately lead to capital flight, people transferring their bank accounts out of Italy into another country, possibly in the eurozone and possibly in euros.

    As economists say, here there are only corner solutions. Either you are 100% committed, or very rapidly you are out.

    Now imagine the not improbable scenario that much of this capital flight goes from Italy to Germany. Now under the eurozone clearing system these transfers would be facilitated by the Deutschbank, and then the D-b would have to recover the money from the Bank of Italy. Now if all this happened very quickly, and in sufficiently large quantities
    the Bank of Italy would in all probability be unable to pay from its reserves, which could send Italy’s problems flying directly into the German financial system.

    This was doubtless one of the topics that the President of the D-b would jhave discussed in that meeting with Joaquim Fels.

  9. Italy is the most likely candidate for dropping out. The other problematic countries (Greece and Portugal) are so much smaller and less developed that the EU could handle them with a little bit of extra money.

  10. don’t forget france – slow growth, 3% deficit, debt ratio rising (up to mid sixties from early fifties in 4 years or so). very pesssimistic piece in le monde today. and no real policy change till 2007 presidentials. even then – what to do – real problem of immobilisme

  11. “don’t forget france – slow growth”

    No, I haven’t forgotten France, but the two cases are not the same. Italy is in a real bind from which it will be hard to get out. France ‘muddles through’. ‘slow’ is better than ‘no’ or negative, which is what Italy has had during the last two quarters (and probably this one). One simple metric: median age in France is 38.85, in Italy it is 41.77. Perhaps you don’t understand why yet, but this makes all the difference in the world.

    The problem in Italy isn’t ageing, it isn’t a bad product profile, it isn’t the euro, it isn’t corruption, it’s all of them together.

    What’s really worrying me isn’t Italy leaving the euro, I think that is more or less inevitable, it’s that the capital flight problem as outlined by Scott in the paper, could force Germany’s hand. From a game-theoretic angle, Germany may not have much alternative but to be first mover.

    I don’t think the cash and notes issue is the important one, but they do have it all readily set up, and since there would be no ‘run’ on the deutschmark, they have less to lose. At least reading Scott I realised why the coins are all different. Notes are much easier, you just run the printing press. I doubt it, but maybe somewhere they’re whirring already, just in case.

  12. Coins are so low value that it would be cheaper to just except the Italian Euro’s as real Euro’s. It would decouple the value of coin money from paper money it wont be the first time in history that that will happen

    ps. I still believe that debt the size of 100% GDP for a state who’s spending is a large share of GDP and has a stable currency is simply not a problem.

  13. “I still believe that debt the size of 100% GDP for a state who’s spending is a large share of GDP and has a stable currency is simply not a problem.”

    It wouldn’t be a problem if it wasn’t for all the other issues. Off the top of my head, I think Argentina’s debt was only about 60% GDP, it certainly wasn’t huge. The question is when it starts to grow, and the dynamic you have makes people begin to doubt you can pay.

    As more and more Italians retire, the deficit will grow and grow, this is the problem. You can increase your liabilities now if you think you will have more money coming in tomorrow (income smoothing), but if you will have less? It is important to remember that this is not just cyclical stabalisation. That the Italian deficit isn’t simply cyclical is spelt out in the EU case for excess deficit proceedings.

  14. The trick is to do the separation QUICKLY, and, if possible unexpectedly. No capital flight can happen if the whole thing is finished within 24 hours, during which all accounts are frozen. All savings and debts are converted to the new currency, people get their banknotes stamped, and the economy runs as usual very soon.

    The other problem is that a country leaving the EMU would instantly become a pariah state because of her poor economic fundamentals. This is another story, however.

  15. I forget to name one other condition, low foreign debt.

    Argentina had a debt that was for a large part in foreign hands. Italy’s debt is mostly internally owned (atleast if you swap foreign owned Italian debt with Italian owned Euro-not-Italian debt)

  16. The trick is to do the separation QUICKLY, and, if possible unexpectedly. No capital flight can happen if the whole thing is finished within 24 hours, during which all accounts are frozen.

    This only works if people trust the new currency. Which, if the changeover is done like this, they won’t.

    Everyone will expect the new lira (or whatever) to tumble rapidly in value. So it will. That’s not so bad by itself; but you’ll see a nationwide “race to the exchange office”, as people rush to get their savings converted into hard currencies.

    Doug M.

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