Italy and the Eurozone

John Kay had an article in the Financial Times earlier in the week, and this seems to have caused quite a ripple around the blogsphere (Eurozone Watch, Economonitor, Claus Vistesen at Alpha Sources). The article was about whether or not it was technically possible for Italy to leave the Eurozone. (Update: Sebastian has a fresh post over at Eurozone Watch Blog continuing the discussion).

John Kay’s conclusion, and it is supported by a very reasoned commentary by Sebastien Dullien at Eurozone Watch Blog (welcome Sebastain and Daniela), is that there is no in-principle technical difficulty in exit. The most authoritative piece of work on this topic that I know of comes from Harvard International financial law specialist Hal Scott. The paper was written back in 1998, and was provocatively entitled “When the Euro Falls Apart“. Despite the title the paper is a tightly reasoned piece of work whose main conclusion is that not only is euro-exit technically perfectly feasibe, in fact the mechanisms which would make this possible were incorporated from the start (in particular keeping independent central banks with their own reserves). I think those who were able to think clearly back then – and were able to use some emotional intelligence – were always aware that there were question marks over Italy’s ability to go the distance.

So the problem is not a technical one. But as John Kay indicates it *is* a political one:

But what of financial and commercial contracts made in euros before A-day but not yet completed?

The simple answer is that an agreement in euros stays in euros. But this is not politically feasible. Italians would not accept that their mortgages and credit-card debts, denominated in euros, would cost them one-third more to repay: and it would be absurd if the bank deposits of Italian residents were revalued by a similar amount.

The relevant principle of international law seems to be that debts are denominated in the currency of the place where they are to be paid. But in the modern world, that question often has no clear answer.”

This then is going to be the question *when* Italy leaves (I say *when* since I have no doubt that she will, the demography makes that inevitable, and here, and here, and here). So it is perfectly coherent to argue that Italy can leave. This however is the moment when the debate normally veers off in a southerly direction – towards Argentina – and Argenitina seems, as usual, to generate more heat than light, since the argument tends to move away from Italy and its specific problems, towards a ‘what really happened to Argentian debate” (welcome new blogger Felix), which is, of course interesting, but sometimes it is helpful to discuss just one thing at a time. So going round a rather more circuitous route, let’s think for a moment about what just happened in Turkey and in Hungary. Two economies which were on an unsustainable external deficit course were brought back sharply into line by a sudden, large drop in the value of the local currency. Judging by posts and comments on this site we seem generally to be agreed that having such flexibility was a good thing, since it enabled these economies to correct and adapt before a big crisis (hard landing) situation built up.

So what about Italy? Well Italy as we know cannot go down this road, and Italy has, in fact, used the cheap finance made available by the eurozone not to reform, but to avoid reforming. This, at least, was the conclusion reached by two highly respected European economists (Romain Duval and Jørgen Elmeskov) in a widely quoted paper entitled The effects of EMU on Structural Reforms in Labour and Product Markets

So Italy is unable to correct, and the inbuilt problem is growing. The Italian economist Francesco Daveri (who is a specialist in technological change and ageing) makes the important point in this podcast for Radio Economics that Italian economic growth *peaked* in the 1950’s at around 5% per annum. Since that time it has dropped steadily at the rate of about 1% per decade, and in the 1990s was at an annual rate of about 1% per annum. Following this trajectory, and what we already know, it is not unreasonable to imagine that this decade the Italian economy will flatline (an average of 0% growth) and possibly enter negative territory in the next one (say -1% pa 2010-2020). Of course this situation makes a complete nonesense of the neoclassical theory of ‘steady state’ growth, but that is a problem for that particular theory, it doesn’t mean that what is happening isn’t hapening (I have a post about this issue in the context of Germany, Japan and Italy on Demography Matters). So the question is, where does that leave the problem of Italian public debt currently running at 105 – 110% of GDP? Unsustainable, that’s where it leaves it. And the only way for Italy really to get to grips with the situation is to recognise that it cannot resolve this problem and default. This default is unlikely to be possible inside the eurozone, and hence Italy will leave. This is a question of simple economics, not popularist politicians.

Which brings us to the last point before the last: won’t this cause chaos? Well of course it will, this is why it would be better that people come to terms with this rationally rather than making it an emotive topic.

Now for the last point. John Kay rightly laments:

Any international bank or business should contemplate these issues. But the consequences of such contemplation are grave: in financial markets, actions to protect against a contingency make that contingency more likely. That is why a debate on the fragmentation of the eurozone is a debate that no one dares have.

And John Kay is right, debate on this topic will probably make default happen sooner. I remember the heartsearching Paul Krugman went through when it became obvious Argentina was going to default. Such situations pose special problems for those economists who can, to some extent, see what is happening. But my conclusion was in that case, and it remains the same today, that if something is unsustainable it is better to recognise this sooner rather than later: quite simply the damage is less. If Argentina had defaulted one year earlier, then the politics of the default transition would have been much easier. Basically, if you ask people to make a lot of sacrifices for a project that can’t work you can hardly blame them if they are not in the mood for another round of sacrifices after it turns out that the earlier sacrifices were in vain. This is as true for the Italy of 2007 as it was for the Argentina of 2000. I think we would all do well to remember that.

This entry was posted in A Fistful Of Euros, Economics and demography 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".

57 thoughts on “Italy and the Eurozone

  1. Two obvious questions:

    How do you wish to discuss such a thing publically? As soon as this is discussed outside academia you’ll get a runaway effect and will be forced into doing it. If people inside Italy switch from Euros into other currencies in large numbers, action will be needed.

    How do you propose to stop the process at one country?

  2. “How do you wish to discuss such a thing publically?”

    Not easy, obviously. One problem here Oliver is that many assume that there is a ‘good’ option. But what if there are only two ‘bad’ options, one of which is less bad than the other?

    These options seem to be to wait and do nothing, or to accept the inevitable. The issue for the eurozone is, is it better to keep a workable core, and thus negotiate a ‘road map’ with Italy (and possibly Greece, or Portugal) for exit? Or is it better to wait till the thing blows up in our faces, and look to an uncertain outcome?

    The argument for doing nothing is not compelling, but I dare say it will win the day. In general terms the ECB is supposed to steer expectations, what they really need to be doing here is giving the impression that they have a plan, not sit twiddling their thumbs.

  3. Oliver, I don’t think that an imminent default would cause Italians to sell their euros for eg dollars, so much as it would cause them to simply move their euros to eg Switzerland. Remember that Italy would be devaluing against the euro.

    As for Argentina, virtually all foreign holders of Argentine debt (with the important exception of retail investors) saw the train wreck coming in plenty good time, with or without the help of Paul Krugman.

  4. I don’t think that an imminent default would cause Italians to sell their euros for eg dollars, so much as it would cause them to simply move their euros to eg Switzerland.

    Do you think such a crisis wouldn’t cause doubt about the principal viability of the Euro? I wouldn’t run the risk.
    What happens to orphaned currencies in foreign accounts? If they’d be unlucky they’d end up with New Lira.

    Secondly, if everybody sees it coming, what good does that? Whom do you sell to?

  5. Furthermore, US$ I get at every bank, likewise Swiss Franc or Pound Sterling. To move money to Switzerland, I need a foreign account. That is troublesome and expensive.

  6. John Kay’s article (like others in the FT) look like a transparent attempt to crack up the EURO project by taking aim at what is perceived to be the weakest country: ITALY. Italy has always used devaluation as an easy way out of economic difficulties. However, right now Prodi (the Italian father of the EURO and principal sponser in Italy) is in charge. Further, Italians have seen interest rates plummet and are enjoying the benefits. Italy does not run a massive external deficit (unlike say the United States or the U.K.) and the level of Italian Private Sector savings is high.

    It would probably suit a lot of people if the EURO project was cancelled, particularly those who currently enjoy RESERVE CURRENCY status. That is not likely to happen ANY TIME SOON.

    And in any case, if you want to pick off a weak member the focus should be SPAIN, which is running a massive external deficit.

    The article IMVHO was a mixture of prejudice and ignorance. Pretty typical of the FT.

    And it will get nowhere.

  7. ‘Italy does not run a massive external deficit (unlike say the United States or the U.K.) and the level of Italian Private Sector savings is high.’

    Hi Paris Ib and thanks for the comment over at Alpha.Sources as well. Since your bottomline seems to be the same I will respond here.

    No it is obviously true that Italy does not run an external deficit but a very large internal one. This is of course a no-no in terms of compliance with the terms of membership in the EMU and consequently Italy is in for a tough round of fiscal tightening in the immediate future. Moreover this is happening at the moment where the cycle is turning and the US is slowing (I think you are right on this one; the US IS in fact slowing). If ever Italy could run an external deficit eh?

    The problem is that it can’t because of the Euro and with an ageing population pushing up the dependancy ratio fiscal tightening suddenly does not look that good. In short … the Euro has locked in Italy. Consequently, Italy has a quite bad economic outlook which is du largely to the fiscal situation, its demographics, and the Euro because Italy has lost competitiveness in key industries. So Italy cannot import to any major extent because it lacks the domestic demand structure to run a large external deficit but it cannot export either because of the Euro.

    As far as the rest of the Eurozone goes … well Germany is running on exports and they are good at it; it will be interesting to see what happens as the US consumer takes a break. Spain is indeed running a large external deficit and the economy is booming fueled by an asset market bubble in houses. This has helped to keep up Eurozone growth at bit upbeat. France probably has the most sustainable outlook if we take the big picture here because it might actually have the internal demand composition to help growth stay up when the US slows. It migth be able to run a deficit.

    Finishing with Italy … I do NOT want to see the Eurozone project explode and I am not trying to talk down the importance of a single currency in terms of the political integration of Europe. I think the Euro is genious idea mainly because I normatively agree with the idea (ideology if you will) of a unified Europe. But in economics we at least try to be objective and as an economist I just can’t reconcile my observations and analyses with the continuation of the Euro in its current form.

  8. An ungrowth of the economy is needed; capitalist economy can’t growth forever.
    Italy is not weak, is avantgardist. 🙂

    If China and India are more and more rich, EU and especially USA must became poor, or “not so rich”.

    The same is for “the standard of living”, here is too high, and it is going to decrease.
    In india and china is growing.

  9. “Italy is not weak, is avantgardist. :-)”

    I smell Nietzsche. This isn’t fair, you are using an aesthetic not an economic criterion. Interesting idea though, an avantguard in wheelchairs, reminiscent somehow of Marco Ferrari.

  10. Hi claus, welcome to afoe.

    I must warn you not to say any good thing about France (even relative) in this forum, as shown by Jerome guest post a few days ago, France must absolutely be “reformed” and copy all the bad policies from other countries, plus French elites and people know less than nothing about economics so it’s impossible that any good thing can possibly happen :).

    And don’t mention France still has the option of fixing its dumb immigration policies and that no government can probably do worse in inefficient spending than Chirac’s one too.

  11. Why would Italians invest in a foreign currency when you also can go cash. Coins are different but the money involved with them is so small that it is unlikely that Italian Euros will be treated any different than Euro coins from other countries. And with paper money you have the problem that checking for the S is much to much work

  12. Hi Laurent …

    Actually I have been around for some time now here at AFOE as a constant lurker and occasional commenter. And yet … I forgot that little detail :).

    You are obviously right and I for one would agree that France needs to do much much better on all the areas you mention; particularly reforms of the labour market would be nice I think. My argument was indeed relative as I implicitly pointed to the fact that the current interest-level set by the ECB might be most adequate for France than for any of the other countries. Furthermore, France has actually picked up the pace a bit lately although I think Edward posted something on France’s service sector slowing down lately?

    Lastly, I am slightly optimistic regarding France as I hope and believe that the new president and his or indeed her ministers will have the legitimacy to carry out some reforms come after the elections. A faint hope perhaps …

  13. “An ungrowth of the economy is needed; capitalist economy can’t growth forever.”

    Now here is an interesting, and frightful, idea. Is it possible to ‘degrow’ an economy in step with declining populations and offset the loss in revenue with better performing means of production?

    Or, could you run a powerful economy with less active people, like downsizing a company?

    I also believe, rather superstitiously, that growth has its limits. It is a vicious circle. A growing population brings the need for larger, and thus growing, economies. To sustain that growth, one needs more people, etc.

    Any big economists out there who have at least attempted to look into a sustainable model for degrowth?

  14. Consider also this quote (from http://www.crvp.org/book/Series04/IVA-23/chapter_vi.htm)

    The Image of Man. The theoreticians of the Club of Rome elucidate the image of man, which at present predominates in Western culture. According to A. Peccei, contemporary man is similar to Gargantua with his “insatisfiable appetite for consumption and possession, ever increasing production, and vicious circle of growth with no end in sight” (1977, 37). Here the significance of man depends on his economic status and material prosperity. “In this way”, he concludes, that “man has gradually turned into a grotesque one-dimensional Homo economicus” (ibid., 17).

  15. Look Italy has run a large Government Sector Deficit for a long, long time. When I was at University total accumulated goverment debt was 120 of GDP. It has come down since.

    What does this represent? I’ll tell you: Italians don’t trust the government, never have. And mostly they avoid taxes blatently and everywhere. But they still want (and GET) free health, free education (all the way to university) and all the doodads of the modern world. So there is an allocation choice here: money stays in PRIVATE HANDS which then gets lent to the Government. This is ITALIAN money, Italian savings. While Italians don’t want TO PAY THE GOVERNMENT for it they always have been prepared to LEND the government money. You may have heard the expression: BOT PEOPLE.

    By opening Italian capital markets (late) and joining the Euro (with everyone else) the Italians got a free ride on Europe and now fund their deficit at very low rates. And a major plus for Italian borrowers. This is a fundamental sea change and represents PROGRESS. They are not gonna back away from that.

    Italians have always been among the most enthusiastic Euro-philes (and founding members of the EEC by the way). Partially this is disenchantment with their government.

    Anyway Italians still export (a LOT) – u know Fiat, Ferrari, Diesel Jeans, Luxottica glasses, Perfume, Textiles, Handbags….. etc.

    And they import a lot: French Champagne (last time I looked they were the biggest per capita market). Their external accounts are NOT A PROBLEM. And the Government Deficit/Debt is a relative problem. With time (and more confidence that the Italian Government is really being run by and for Italians and not – for example – suffering from overseas interference) and better tax collection methods the Government Deficit will fall.

    In any case Italy has been running a Primary Surplus (that is ex-interest payments) for AGES. The problem is the service cost of a large accumulated debt. Exit from the Euro would ratchet that COST UP. It’s a no go.

    Basically John Kay DOESN’T KNow what he’s talking about. And (with respect) neither do most of the commentators I’ve heard talks about this issue. NO IDEA. Cheers.

  16. And this, by the way:

    Italy cannot import to any major extent because it lacks the domestic demand structure to run a large external deficit but it cannot export either because of the Euro.

    is complete mumbo jumbo.

    What does that mean?

    Italy lacks the domestic demand structure to run a large external deficit….. excuse me?

    Don’t know what drugs you are on, but they must be GOOD. Just more psuedo-rot signifying NOTHING.


  17. Now here is an interesting, and frightful, idea. Is it possible to ‘degrow’ an economy in step with declining populations and offset the loss in revenue with better performing means of production?

    Consider things this way: which is more important – GDP or GDP/capita? If you are average citizen of a country, GDP/capita is surely more important — a country whose population and GDP both grow at 2%pa does not have citizens who are getting richer. BUT if you are an investor, then GDP, as a proxy for the pot of money available to be returned to you is of more interest than GDP/capita.

    OK, now ask yourself, in the press (financial and popular) how often do you hear about GDP growth, vs GDP/capita growth?
    You’ve just answered the original question.
    The average citizen stands to lose nothing from a GDP that shrinks in lockstep with population. But the people that control societies, ah, they stand to lose a lot. Which means that we will be hearing plenty of stories about various things that need to be done (probably wrapped in that old standard, “reform”) to cope with a shrinking population, almost all of which are, to put it bluntly, outright lies promulgated for only one purpose which is to offset, for the rich, the losses expected to result from a shrinking GDP.

  18. Hi again Paris Ib,

    Regarding your analysis of the the Italian budget deficit … Well let us go along with it for a moment and assume you are right then we still end up with an Italy who probably will have to suffer from domestic inflation in the effort to comply with the demands of convergence set by the Eurozone for some time ahead. I don’t think better taxing collection methods are a viable remedy here.

    Italy still exports a lot …? Hmm well, I am not sure I agree quite with your list there; ‘textiles and handbags’ … are these things not made in China and Vietnam now? Ferrari … a wonderful car is it not? Yet I am unsure Italy can count on this too much on this one in the large perspective. Fiat, well this is definitely a source of exports but vis-à-vis other carmakers, notably Asian ones, competitiveness has been declining for some time now.

    Oh and this one …

    ‘Don’t know what drugs you are on, but they must be GOOD. Just more psuedo-rot signifying NOTHING.’

    Well nothing special really nothing special … it is called caffeine.

    And lastly …

    ‘Italy lacks the domestic demand structure to run a large external deficit … excuse me?’

    Well I am sorry but I actually was rather serious about this one. Germany has a bit of the same problem, Japan is one to watch here as well. Globally, USA has been doing most of the importing lately although Spain in the Eurozone definitely also has the so-called domestic demand structure to run a large external deficit. On a global scale we call this global imbalances and much has been written about this in the econsphere … go check out some of it.

    Cheers

    Claus

  19. Maynard, interesting. So, if I understand it correctly degrowth should be possible. Any ‘hard’ links to go with your theory? Also, how would GDP per capita offset maintenance of those who are not active (pensions, healthcare, welfare) and of infrastructure, etc.

    I am serious, even though I am not an economist, and I am trying to find serious information on degrowth.

  20. “Italy cannot import to any major extent because it lacks the domestic demand structure to run a large external deficit but it cannot export either because of the Euro.

    is complete mumbo jumbo.

    What does that mean?”

    What it means Paris is what I think Claus is trying to explain. What we now know (but probably earlier generations of theorists didn’t) is that as the demographic transition continues its course population median ages rise steadily.

    Now at the top of the list here are currently Japan, Italy and Germany. This, I take it, is what von ko could be driving at when he describes Italy as the ‘avantguard’.

    Now we notice some interesting phenomena in the context of these societies. One of these is that the balance between current domestic demand and saving seems to shift. This is not surprising in the light of the life cycle model of economic behaviour, since people seem to have a tendency to save more rather than borrow more as they get older. So these societies tend to have a structural weakness in their internal demand.

    Now Geramany and Japan have a very strong export profile, so they can basically maintain momentum by running an external surplus. But Italy isn’t in a position to do this, indeed it has recently been tending towards deficit. But as Cluas suggests, given its internal demand structure it can’t sustain this deficit. This is what all the fuss about the ‘product profile’ is all about really.

    Italy has both a weak internal demand structure *and* an insufficiently competitive export sector. This is why it constitutes the weakest link in the global economy at this time. And this is why there is so much concern about the government debt dynamics.

    Of course the rhetoric of being rude to those you don’t agree with is normally thought to be a sign of weakness in debate.

  21. Guy,

    “Now here is an interesting, and frightful, idea. Is it possible to ‘degrow’ an economy in step with declining populations and offset the loss in revenue with better performing means of production?”

    I would say that this is the big question, and we don’t yet know the answer to it. Addressing this is obviously a work in progress. It is the topic of the times, and is, and will continue to be, a source of discussion and debate on this site.

    “I also believe, rather superstitiously, that growth has its limits. It is a vicious circle. A growing population brings the need for larger, and thus growing, economies. To sustain that growth, one needs more people, etc.”

    This is a much bigger, but no less important question. Economists historically have not known what to do with this one. Not that they thought about it in population terms, normally it was a ‘living standards’ question. I think most of the ‘big picture’ economists who thought about this were aware that there was an issue here. Since ‘need’ is, as you suggest, effectively a kind of bottomless pit, or black hole, there is no way ‘needs’ can ever be satisfied. And the constant search for growth is a bit like chasing after your own shadow, it has the ‘feel’ of being a sign of immaturity, so couldn’t our societies and economies one day mature and break out of the vicious circle.

    Keynes certainly felt this, and had the hope that by the end of the last century so much would be being produced that material ‘needs’ would become a thing of the past, This hasn’t been like this as we can now see, but the reasons why it hasn’t may be worth looking into. This I see as one possible area of future discussion.

    But to get from where we are now, to where we might like to be on this front I think there are certain key points we need to bear constantly in mind, and these relate to ‘transitional dynamics’.

    Before explaining what I mean by this I would suggest that we need to keep one thing clear: growth and technical change are not one and the same thing. Technical change – hopefully – will never come to an end (this is, in one sense, what we mean by evolution), and technical change is, if anything, accelerating. But growth is an economic phenomenon and it is about values and prices within a determinate system, and especially about relative values and prices.

    So I think the key points about the forth coming transitional dynamics are:

    i) The inter-generational issues in developed economies. Honouring inter-generational commitments implies growth to some extent during a transitional period. Otherwise you will simply crash pension and wefare systems.

    ii) Also the under-developed part of the world needs to come into line with the rest. Obsessions with excess growth seem to be a first world issue at present. First we need to address the development needs of the third world. So I don’t think it would be very desireable or responsible to go for ‘negative growth’ at the expense of the world’s poor.

    However, sometime this century global population will peak, and claerly by the time this happens we need to be a lot further along the road with the isssues you rightly raise, since in economic terms ‘growth’ in the conventional sense of the term may well become a thing of the past.

  22. Now Italy may leave the Euro because of a demographic problem? Aging population? You can’t be serious.

    Right now there are thousands of immigrants lining up to live in Italy. There is no demographic problem which can’t be solved either via immigration or via tax changes (which is how the French solved their ‘aging’ population problem).

    Your comments suggest that none of you have a handle on Italian economics, preferring vague rubbish about ‘demand structure’.

    Italy does not have a large external debt, does not run a massive trading deficit with the rest of the world (and this is because it REMAINS competitive – regardless of the misinformation out there) and tends to channel capital into productive investment rather than into consumer spending (which provides no return) or speculative residential investment (which also provides no real productive return).

    Why would Italy suffer inflation by trying to meet convergence criteria? If anything budgetary tightening is likely to have the opposite impact: deflation. This is not analysis it is just words.

  23. Maynard

    “The average citizen stands to lose nothing from a GDP that shrinks in lockstep with population.”

    This depends on the dependency ratio within any given society. I don’t think it is anything like as straightforward a question as you are implying.

    “If you are average citizen of a country, GDP/capita is surely more important — a country whose population and GDP both grow at 2%pa does not have citizens who are getting richer. BUT if you are an investor,…”

    Again, I think you are over-simplifying here, since in terms of inverting population pyramids and pensions systems first world citizens are all, to some extent, becoming investors. One way to balance some of the global imbalances is to transfer first world savings into third world investments.

    “Which means that we will be hearing plenty of stories about various things that need to be done (probably wrapped in that old standard, “reform”) to cope with a shrinking population, almost all of which are, to put it bluntly, outright lies promulgated for only one purpose which is to offset, for the rich, the losses expected to result from a shrinking GDP”

    Well, as long as we understand by ‘rich’ here the populations of developed first world economies who will be investing in rapidly growing developing ones. Fortunately there are, at present, no shortage of these (although this, as I am indicating is simply a transitional situation). Obviously India, China etc are all set to take up a lot of the GDP growth slack. This quote from Stephen Roach illustrates the point reasonably well:

    Global Speed Trap

    GEF 11/09/06

    Of course, the flip side of China’s rapid ascendancy has been the equally swift decline in global leadership of the former titans — especially Japan and the United States. For IT products, Japan went from a #1 position of 20.4% of all global exports in 1990 to #5 with just a 7.9% share in 2004. Meanwhile, US market shares in IT exports went from 19.3% in 1990 to 11.0% in 2004. A similar decline is evident in communications equipment. Japan went from an overwhelmingly dominant position with 26.7% market share in 1990 to #5 with just a 6.9% share of global exports in 2004. US market share in global communications exports was essentially cut in half over the same period — from 13.9% and a #2 position in 1990 to a 7.0% share and a #4 position in 2004. Interestingly enough, Germany has held its own in both of these two leading-edge export businesses; its 6.9% share in global IT exports in 2004 is only fractionally below that prevailing in 1990, whereas its share of global communications equipment actually inched up from 7.4% in 1990 to 8.9% in 2004.

  24. “Now Italy may leave the Euro because of a demographic problem? Aging population? You can’t be serious.”

    Yes, this is exactly what I am saying. And I’m not saying ‘may’, I’m saying WILL.

    And one of the reasons I am so sure is that so few people are taking this problem seriously. Hence it is not being addressed.Your comments are a perfect ilustration of the state of affairs we have at present.

    “If anything budgetary tightening is likely to have the opposite impact: deflation.”

    Obviously, and this is what is about to happen. And curiously, the more they deflate and the less they grow the more they will have problems financing the deficit. This is now a vicious circle.

    “This is not analysis it is just words.”

    Well beauty is, as always, in the eyes of the beholder :).

  25. Thanks for your comments, Edward. I do not have time to delve deeper right now, but the ‘third world’ angle is definitely important. You cannot degrow in a vacuum.

    I think I’ll copy and paste this discussion to a post on my own blog, so that I can find it back whenever I have some time to think more deeply about it. There have been plenty of discussions/comments lately on AFOE that are worth saving as posts of their own 🙂 It is hard to keep up.

  26. “There have been plenty of discussions/comments lately on AFOE that are worth saving as posts of their own 🙂 It is hard to keep up.”

    This is the problem with being cursed to live in interesting times. Incidentally, I have just got back to a point of yours on the analytic philosophy thread.

  27. So when Claus said:

    “Italy who probably will have to suffer from domestic inflation in the effort to comply with the demands of convergence set by the Eurozone”

    he actually meant the OPPOSITE (according to Edward).

    Bizarro world analysis.

    And if it’s demographics we have to worry about then can someone please explain how Italy reduced its outstanding Government Debt while these demographic trends were already in place.

    You guys have no idea about the economic reality in Italy. One stat you may like to ponder: household debt to income ratios are currently around 35%.

    In Australia they just hit 177%. What are they where you are?? Give me a number.

    I’d like to see more REAL NUMBERS quoted here and less waffle. The Italy will leave the EURO is a pipedream and the numbers don’t support it.

  28. “he actually meant the OPPOSITE”

    It could well be just that, a typo. But then Claus is well able to speak for himself. You know we don’t all have to agree all the time here. That is what discussion is all about.

    “household debt to income ratios are currently around 35%.”

    Exactly, this is the point, they are saving not borrowing.

    “In Australia they just hit 177%”

    Ah, so this would be Paris New South Wales we are talking about here :).

    “And if it’s demographics we have to worry about then can someone please explain how Italy reduced its outstanding Government Debt while these demographic trends were already in place.”

    Yes, this isn’t hard, this is a transition, and they are now further along the road. This is what the whole Lisbon strategy is about. And if you don’t like it I suggest you take your beef up with the Commission in Brussels and those over at the ECB since it seems they don’t know what they are talking about either. Oh, and you if you happen by the Paris which is in France, the OECD offices also have all the data you seem to lack on this:

    http://www.oecd.org/country/0,3021,en_33873108_33873516_1_1_1_1_1,00.html

  29. If u could put 2 and 2 together u would realise that Italy’s Government Deficit/Debt is the reason Italy WILL REMAIN in the EURO.

    * Italy runs a primary Govt Surplus.
    * Interest payments on existing debt comprise the entire Deficit.
    * Interest rates in Italy have FALLEN enormously since Italy opened up international capital flows and STILL MORE when Italy joined the EURO.
    * Hence joining the EURO has enabled Italy to service its existing Government DEBT at lower rates. Therefore it is in Italy’s interest TO REMAIN in the EURO.

    * Italy does not have a problem with its external accounts HENCE devaluation is not an issue or a RESPONSE to a problem.

    Think. Don’t just parrot misinformed prejudice.

    Demographics is a non-issue. You may as well discuss the ozone layer or peak oil or some other totally UNRELATED FACTOID.

  30. Well, well, what a surprise, look what just came in across the wires:

    Italian Industrial Production Unexpectedly Declines

    Italian industrial production unexpectedly fell in July for the first time in three months as near-record oil prices raised manufacturing costs and weighed on consumer demand.Output declined 0.3 percent from the previous month when it gained 0.1 percent, the national statistics office Istat said in Rome.Output dropped 0.2 percent from a year earlier.

    I’m certainly not gloating here, the livelihood of too many decent people is at stake. But I have been p***ing into the wind on this so-called ‘sustained recovery’ in Germany, Japan and Italy for six months now, and the data are finally starting to show who has been right.

  31. If u could put 2 and 2 together u would realise that Italy’s Government Deficit/Debt is the reason Italy WILL REMAIN in the EURO.

    * Italy runs a primary Govt Surplus.
    * Interest payments on existing debt comprise the entire Deficit.
    * Interest rates in Italy have FALLEN enormously since Italy opened up international capital flows and STILL MORE when Italy joined the EURO.
    * Hence joining the EURO has enabled Italy to service its existing Government DEBT at lower rates. Therefore it is in Italy’s interest TO REMAIN in the EURO.

    * Italy does not have a problem with its external accounts HENCE devaluation is not an issue or a RESPONSE to a problem.

    Think. Don’t just parrot misinformed prejudice.

    Demographics is a non-issue. You may as well discuss the ozone layer or peak oil or some other totally UNRELATED FACTOID.

  32. Goodness me. So Industrial Production is down 0.2 on a year earlier. Should we care?

    NO.

    Have u seen manufacturing data in the States or the U.K. recently. Do u understand what “Debt Binge” means? Do u understand that borrowing to finance CONSUMPTION is a borrowing without RETURN which means POVERTY ahead.

    What is the problem with you guys? Why can’t you admit that the Anglo economic model depends on the great con trick: the USD is a global reserve currency, give us your money we will keep it safe for u (meaning piss it away on Consumption and WAR. Oh and maybe some completely new and useless SPACE PROGRAMME).

  33. “What is the problem with you guys? Why can’t you admit that the Anglo economic model depends on the great con trick:”

    I think you are in the wrong thread here Paris, this is just not the debate on this site.

  34. Oh and this:

    Link

    I know a lot is riding on the U.S. convincing the world NOT TO USE AN ALTERNATIVE TO the USD as a Global Reserve, but it looks like the Game is UP BUCKO. Bravo for John Kay and that guy Wolfgang whatshisname for trying to undermine the EURO. Don’t matter.

    The interesting thing about keeping something at a value which fundamentals don’t support (say for argument’s sake the USD) that when the ADJUSTMENT comes, IT’S A COLLAPSE !!

  35. When someone (say John Kay in a newspaper say the Financial Times) writes stuff which suggests that the EURO is going to fall in a heap – starting with Italy (say their favourite target right now for undefined reasons) that it’s fair to suggest that MAYBE the real AIM is to hold afloat the USD (as THE international reserve currency). THAT’S how I read it.

    And therefore discussing the parlous state of the U.S. economy, the risk to the USD and the whole Anglo SHAM does belong on this thread.

    At least as much as the ozone or demographics do.

  36. Yes, I wonder why external debt should be so important? After all, foreigners cannot vote you out of office, but domestic voters can if you wipe out their retirement fund.

  37. Oliver, They can vote you out of office but politicians are only a limited time politician in which, with a bit of luck, nothing bad happens. Domestic debt is a problem but you have the guns so if they don’t want to lend it to you you can always ask for it forcefully.
    This isn’t so successful with foreign debt and that is a real big problem if you need that to import necessities.

    Paris ib, the whole economy is one gigantic con. You would be right that debt binges don’t work except for the fact that they do seem to work.

  38. As a thought-experiment, suppose Italy were to announce a sovereign default, without leaving (or being kicked out of) the Euro. Clearly, those who hold Italian government debt are left holding the bag, but by the time it came to this, one would expect that Italian government debt carried a substantial risk premium, and those who bought it would know what they were getting into.

    But is there any mechanism by which the risk of Italian sovereign default is spread onto those who don’t hold Italian government debt? If it suddenly turns out that a particular financial vehicle was a bad investment, why should that necessarily put pressure on the currency that investment happened to have been denominated in?

  39. “As a thought-experiment….”

    Good, this is the way to do it.

    “without leaving (or being kicked out of) the Euro.”

    This is impossible. In the first place this wouldn’t be allowed. But in the second place, following the thought experiment line, even if it were hypothetically possible, think what would happen.

    Sebastian Dullien is right, capital flight from Italy wouldn’t go to Switzerland, it would go in euros to other zone member banks. Now, it is very important here to remember that the member state central banks have no right to print euros, so the liabilities which were generated by the transfers would have to be honoured by the Bank of Italy out of reserves, and they couldn’t be made by using paper (bonds) since other banks would now not accept these. The whole inter-bank transfer system would immediately break down, ie it would be stopped even before it happened. My guess is that the ECB already has a contingency plan about what to do if serious flight out of Italy starts, since once it starts it will be impossible to stop.

    They would be fools not to have a plan, but as Oliver would say they obviously can’t tell anyone this.

    “one would expect that Italian government debt carried a substantial risk premium”

    The thing is, this was the theory, that there would be a risk spread across the national bonds, and to a small extent there is, but this is kept in very tight bounds by the ECB accepting Italian debt at par. Once the ECB stopped doing this, and people had to trade non-guaranteed bonds, my guess is that the risk premium would suddenly spike, and the Italian government would have to start paying a lot more to raise money, something which, in and of itself, could precipitate the default dynamic.

    “why should that necessarily put pressure on the currency that investment happened to have been denominated in?”

    You are talking about the euro itself here. I wouldn’t even vaguely want to get into what the secondary consequences of this would be, I don’t dare to think of them, and anyway no-one really knows. It depends if the ECB was seen as being in control of the situation, and this is why I would be proactive here, and not be waiting to be sucked along by events.

  40. “Yes, I wonder why external debt should be so important?”

    I hope I answered this in the last comment, it’s to do with reserves. Basically if you have a capital outflow as people cash in their bonds, someone has to fund it. Internally this isn’t such a problem. Obviously if you could just print euros this wouldn’t be a problem. This is why they aren’t allowed to do this.

  41. Basically if you have a capital outflow as people cash in their bonds, someone has to fund it.

    Actually, to continue the thought experiment, why has anybody have to do that? Who is forced to buy Italian bonds?

  42. “Actually, to continue the thought experiment, why has anybody have to do that? Who is forced to buy Italian bonds?”

    Oh, that’s easy, the ECB and other eurozone central banks. That is what the zone is about. This is the guarantee. If the ‘risk premium’ on Italian bonds started to rise beyond a certain limit, the slack would be taken up by central bank purchases. This is the dilema.

    If the ECB step back and refuse to guarantee, then the risk differential begins to spike, and Italian government finance gets into a lot of difficulty.

    Don’t forget that the eurozone central banks face significant loses on the capital value of their Italian bond holdings if the Italian rate rises, since this means that the market value of the bonds drops.

    If the guarantee is withdrawn and the Italian government has to sell in open auction to people who want to buy in these conditions, then they will have to pay a rate of interest which attracts purchasers.

    I can’t remember exactly, but maybe the Argentinian government was paying 20% in 2000. Remember, some people can factor-in default, and take a guess at the kind of haircut to expect. There is a market in ‘junk bonds’ remember. Basically some people are prepared to gamble on anything :).

  43. One other point. I resisted getting dragged off by Paris into another discussion altogether, partly because I don’t think what was happening was a constructive discussion (ie one where you can learn things), and I think this post is mainly about Italy and not about the US.

    But that doesn’t mean that the issues he raises aren’t important ones. Basically all of this is riddled with inter-connections.

    The level of private indebtedness in the US is obviously a cause of concern for everyone, as is the continuing US trade deficit.

    I have been having an ongoing debate with Brad Setser on precisely this. I differ from Brad, since I don’t see how, in the short term, the global system can correct. This doesn’t mean that in the long term the situation isn’t preoccupying, especially from the US point of view.

    The question isn’t *that* people are getting into debt, the question is *why*.

    Principally this has to do with interest rates. My argument is that globalisation means that interest rates, especially long-term ones, aren’t set locally in the way that they used to be 20 years ago. This greatly restricts the clout of the Fed in the US.

    Interest rates are set by global demand for and supply of savings. It is really as simple as that. And if there is an increase in the supply of savings in relation to the demand for investment, then interest rates will be lower.

    My feeling is that if the global economy slows in 2007, then we will once more see interest rates coming down, try as hard as they might in the G7 and the central banks to push them up.

    And one of the reasons why there is this changed balance between savings supply and investment demand *is* demographic (note *one* of the reasons), and results from the various stages of the various societies in an ongoing process known as the demographic transition. Beyond saying this, I think we have here the subject matter for another post and another debate someday.

  44. Yes indeed.

    Can global imbalances be corrected? How? And what will be the consequences.

    Big questions. No easy answers. But it could determine the economic future.

  45. Now has anyone else got any further points on Italy they would like to take up?

    Actually, yes, but real short. When I was discussing Italy’s probability of entry into the Euro with Italian official back in the mid 1990s, one very smart young official told me something like the following: we can discuss the economics forever and never agree. But we should always remember that what this boils down to is, does Italy prefer being part of Europe or would it like to join north-africa (no racist pun intended here). I saw this as a profound truth and this led to my greatest forecasting success in many years. Perhaps, we should still look at this issue along the same lines, not least because the guy in charge is the same guy as in the mid-nineties, and in fact succeeded the same incompetent chap (remember Krugman: there is a difference between runnng a country and running a company) as in the mid-nineties.

  46. “does Italy prefer being part of Europe”

    Of course. But being part of the eurozone and being in the EU are not synonymous, as Sweden, Denmark and the UK illustrate. Indeed of the current 25 EU members only 12 are in the eurozone. If Italy does give up the euro at some point it will be interesting to see how all the acrimony this will produce is handled, by I am certainly not suggesting that Italy will leave the EU, this is not the point.

  47. Sweden and Denmark would still be part of Europe for cultural reasons while Italy is a corrupt version of Tunisia (maybe an exaggeration) .

Comments are closed.