Is 2008 Make Or Break Year For Italy’s Economy?

As Italians head to the polls this weekend in order to pick what will be their 62nd government in 65 years (in an election which is being held three years early to boot, due to the collapse of Romano Prodi’s outgoing administration) one odd detail seems to stand out and sum up the multitude of political and economic woes which confront Italy at the present time: we still don’t have economic growth figures for the last quarter of 2007. Now this situation may well be an entirely fortuitous one – Italy’s national statistics office ISTAT are in the process of introducing a new methodology to bring their data into line with current EU standards as employed in other countries (Italy yet one more time is at the end of the line here, but let’s not get bogged down on this detail) – but there does seem to be something deeply symbolic about all this, especially since Italy may well currently be in recession, and may well be the first eurozone country to have fallen into recession since the outbreak of the global financial turmoil of August 2007.

Perhaps the other salient detail on this election weekend is the news this (Saturday) morning that “national champion” airline Alitalia is near to collapse and may have its license to fly revoked, at least this is the view of Vito Riggio, president of Italy’s civil aviation authority, as reported in Corriere della Sera.

“If something isn’t done soon, everyone must realize that Alitalia is on its last legs…. The authority will have no choice but to revoke the airline’s license “in two, maximum three weeks if it can’t show it can find cash to stay in business”

And – as if to add insult to injury – only this week the IMF revised down yet one more time their 2008 forecast for Italian GDP growth, on this occasion to a mere 0.3% , and (as we will see below) a steadily accumulating body of data now clearly suggest that Italy is already in recession, and may well have entered recession sometime during the last quarter of 2007. If confirmed this will mean that Italy will have been in-and-out of four recessions in last five years. So the real question we should be asking ourselves is not be whether Italy is in a recession, but when in fact she entered it, and even more to the point, when will she leave? Continue reading

When The Curves Invert

Two bits of news this week appear to be unrelated. The interesting question is whether appearances are once more deceptive.

Firstly the US Treasury note situation:

At 6:23 am ET. the 10-year note yielded 4.393 percent while the two-year note yielded 4.396 percent.

Or as the FT puts it:

Yields on 10-year US Treasuries briefly fell below those on two-year notes on Tuesday for the first time in five years – a rare event that in the past has often heralded a recession.

Now there is – more or less – a consensus of opinion that this is not a harbinger of imminent recession this time round. So what then does it mean? Aha, would that we knew! There has however been another curve inversion was officially announced during the last week. According to this AFP report:

Japan’s population fell for the first time in 2005, the government said, calling it a “turning point” that will force the world’s second largest economy to adapt to a rapidly aging society….Deaths are likely to outnumber births by about 10,000 this year, the first decline since 1899 when Japan began compiling the data, health ministry figures showed

.”

The data suggest that Japan’s population may actually have been falling since October 2004.So where might the connection be? Well, back in April the soon-to-be Fed Chairman Ben Bernanke made his now notorious Global Savings Glut speech. In that speech he said the following:

one well-understood source of the saving glut is the strong saving motive of rich countries with aging populations, which must make provision for an impending sharp increase in the number of retirees relative to the number of workers. With slowly growing or declining workforces, as well as high capital-labor ratios, many advanced economies outside the United States also face an apparent dearth of domestic investment opportunities. As a consequence of high desired saving and the low prospective returns to domestic investment, the mature industrial economies as a group seek to run current account surpluses and thus to lend abroad

So he was arguing that ageing populations tend to increase the savings motive and produce an investment dearth. This flow of savings looking for investment tends to nudge down global interest rates. Perhaps the best discussion I have seen anywhere of the inversion phenomenon is this one from the Morgan Stanley GEF team. Clearly this is a complex problem, and they themselves have no consensus, but I did note this point from the Japan-based Robert Feldman:

In how many of the eight inversions over the last 40 years were international markets as closely intertwined as they are today? My point is that, as long as Bank of Japan still has huge quantitative easing in place and the yen carry trade is alive and well, part of the yield curve flattening in the US will be due to international factors and doesn’t necessarily signal a recession

.”

Here there are two points, the increasing efficiency and integration of global capital markets, and the special situation in countries like Japan. So to return to where I started, are the two inversions related. My answer would be a qualified yes. There is some relation. The hard part is to determine the nature and extent of the relation.

A curious trend in the Balkans

2000-2004: Under the rule of the Social Democrat Party (PSD) and Prime Minister Adrian Nastase, Romania enjoys four consecutive years of rapid economic growth. Romania’s GDP increases by an average of nearly 6% per year; for the first time since the end of Communism, the country has four years without a recession. Meanwhile, Romania joins NATO and is accepted for EU accession in 2007.

December 2004: voters reject Nastase and PSD, voting in the opposition in a weak coalition government.

2001-2005: Under the rule of the National Movement Simeon II (NDST) and Prime Minister Simeon Saxecoburgotski, Bulgaria enjoys four consecutive years of rapid economic growth. Bulgaria’s GDP increases by an average of around 5% per year; for the first time since the end of Communism, the country has four years without a recession. Meanwhile, Bulgaria joins NATO and is accepted for EU accession in 2007.

June 2005: Voters reject Saxecoburgotski and NDST, voting in the opposition, which now appears likely to form a weak coalition government.

2001-2005: Under the rule of the Socialist Party and Prime Minister Fatos Nano, Albania enjoys four consecutive years of rapid economic growth. Albania’s GDP increases by an average of about 6% per year; for the first time since the end of Communism, the country has four years without a recession. Meanwhile, Albania is accepted into the Partnership for Peace and moves from being an impoverished semi-pariah to a serious candidate for EU accession sometime in the next decade.

July 2005: Voters reject Nano and the Socialists, returning to former President Sali Berisha, out of office since 1997. Berisha will form a coalition government with several minor parties.

What’s going on here?
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Italy: Devaluation or Deflation

Italy is in recession. There is nothing extraordinary about this, as Donald Rumsfeld notoriously said ‘stuff happens’, and economies do have their ups and downs. But this recession is a little different, since it is structural and not cyclical. For the Italian economy to return to a better trajectory something has to be done, but what? Morgan Stanley’s Vicenzo Guzzo offers two alternatives: devaluation, or deflation (actually the way he puts the alternatives it sounds to me more like a case of: “with which instrument would you prefer I cut your throat sir, the stanley knife or the chain saw”?).

If Italy intended to restore the pre-1999 competitiveness level, it would have to experience a 25% currency depreciation. While the euro is now down over 5% from the start of the year, such a large correction appears unlikely at this stage. In addition, the economy has steadily lost ground also vis-?-vis its euro area trading partners, as the breakdown of the trade data suggests. Euro depreciation would provide no oxygen on that front. In order to return to pre-1999 competitiveness levels, Italy would have to abandon the current exchange arrangements. To put it bluntly, it would have to drop out of EMU. A 25% devaluation is equivalent to what the economy experienced between 1991 and 1995. Exports scored double-digit gains in the aftermath of the realignment, but domestic demand fell heavily and debt services costs hit 12.5% of GDP. In a replay of those years, Italy would either default on its debt or run toxically tight fiscal policy. This is simply not an option, in my view.”

So Italy is caught. To devalue it would have to leave EMU. But then even if it could and did, it would go bust. So, on Guzzo’s reading, the only remedy left is substantial deflation, that is an ongoing reduction of wages and prices which would enable competitiveness to be restored. This sounds very much like the 1930’s and an Italy stuck with a modern version of the gold standard. It also sounds like going through a recession which could turning out lasting for a number of years, even if this was politically feasible it would be extraordinarily painful for many of those most immediately affected.

This, of course, is a question which is widely treated in the textbooks. So would anyone like to suggest a rival ‘escape strategy’?

The Price of Obesity

Economist for Dean Lerxst gets hold of something really interesting in a post yesterday ( which Calpundit also picks up on). He draws our attention to the fact that some US economists have recently been arguing that there has been a significant rise in individuals claiming disability benefits and this has taken a large number of workers out of the labor force, thus – at a stroke – reducing the “official unemployment rate”. The research by Mark Duggan and David Autor is discussed in a NYT op ed by University of Chicago Professor Austan Goolsbee.

Lerxst also highlights the significant role obesity may play in this. He cites an article in Friday’s Wall Street Journal describing a new study by RAND Health economists showing that obesity may actually be the “primary” explanation for the rise in the disability rolls. According to Dana P. Goldman, director of health economics at Rand and the principal investigator on the study cited in the WSJ there is “evidence to support (the idea) that obesity may be a primary reason.”
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