Italian debt of 140% of GDP sounds bad but it is IMHO not in the dangerzone. As state they have a captive market while the Euro makes sure that they their interest rate on their debt is very close to inflation

OK, this is clear, I was making an analogy. The arrangement that Argentina had with the US was a lot nearer to the arrangement that Italy has with Germany than the relation between two US states that is often used as a comparison.

I mean I think the use of euro notes for holiday purposes is really worn out as an excuse for having a common currency. The Brits still have the pound and they seem to have no difficulty coming on holiday in Spain.

Apart from black money - when did you last see a 500 euro note? ( half of euro notes in circulation in value terms are high denomination: ie for black money purposes) - the more important issue is electronic money.

Curiously the analogy with Argentina stretches further, since the experiment was guaranteed by the IMF which is ultimately funded by the US, just like Italy is indirectly guaranteed by Germany.

You could also say the US and China were wedded in an ‘unholy’ monetary union, with Greenspans liquidity push funding the property boom in Shanghai.

Really the difference between China and Argentina in this sense is that Argentina got caught on the dollar ride up, while China has ridden the dollar down. If the yuan had been pegged to the euro since 2002, you wouldn’t be hearing any complaints just now.

“It is not like a default on Italian debt is a problem for the other Euro countries because they can’t be forced to pay it back.”

No, I don’t think Italy would be forced out, I think they’ll want to leave. It will be the ability to devalue that will be the issue, and the need to burn-off the government debt with inflation, the ECB will never permit this, and I don’t think they can pay it off, not without cutting back spending so much that they provoke a massive deflationary recession.

Whoever said economics was a ‘dismal science’. I think it’s exciting, and at times hilarious. The important thing is to not make the mistake of taking money too seriously. It’s only business.

“Edward, according to the Dutch central bank the Dmark was overvalued relative to the other Euro currencies so substituting Dmark for Euro is the wrong thing to do.”

Yep, we had this in another post, about Zalm. But the point is if the Deutschmark were an independent currency, then they could steer it down from the German central bank, without forcing through all this wage deflation they have to get into at the moment.

The reason for leaving the Euro is also very important. If Holland would decide tommorow to leave the Euro than there would be no real problems. They could say that in 3 months the banknotes would switch and there wouldn’t be a run on the banks. But if Italy would be forced to leave than all bets are off. But i don’t see a way why a country would be forced to leave. It is not like a default on Italian debt is a problem for the other Euro countries because they can’t be forced to pay it back.

Edward, according to the Dutch central bank the Dmark was overvalued relative to the other Euro currencies so substituting Dmark for Euro is the wrong thing to do.

The truth is, I don’t know.

“What about accounts in other EU member banks by Italians?”

Not affected, the Eurozone is not a country. Just like intelligent Argentinians who had dollar accounts in New York.

“And what of foreigners diposits in Italian banks?”

Losers probably, unless they denominate the accounts as something like non-resident dollar accounts. I don’t know enough about banking law here. But being a Spanish citizen with a euro governed account governed by Italian law wouldn’t give you any protection if this were to happen I’m afraid.

Obviously and basically there would be a hell of a mess.

On another front the argument continues about pricing in:

“The euro rose from a seven-month low against the dollar on speculation the currency’s four-week drop is an overreaction to the probability French voters will reject the European Union constitution in a referendum on May 29.”

“Lehman’s Call

The euro may rise to $1.30 should French voters unexpectedly approve the EU treaty because investors are expecting a rejection, said Lehman Brothers Holdings Inc.

Europe’s currency is likely to rise more on a “yes” vote than it would drop on a defeat because “a ‘no’ vote is probably about 80 percent discounted by investors,” wrote James McCormick, Lehman’s London-based head of global currency research, in a report to clients yesterday.

“A `yes’ vote, which is not discounted, would probably have a more pronounced positive effect on the euro,” he wrote.”

http://www.bloomberg.com/news/markets/currencies.html

What about accounts in other EU member banks by Italians? And what of foreigners diposits in Italian banks?

DSW

This Oliver is the *big* question. My feeling is nobody really knows. I haven’t made up my mind exactly what I think yet, when I do, I’ll post something.

Meanwhile, if you’re really interested in this, you’re on the wrong blog :).

You should go to:

http://www.roubiniglobal.com/setser/

This afternoon should be a good time:

“I’ll try to chime in with some thoughts on Bretton Woods two late tomorrow — [UPDATE -- MAKE THAT FRIDAY]”

The thread should be warming up anytime soon. In the red corner Roubini/Sester and in the blue Michael P. Dooley, David Folkerts-Landau and Peter Garber. If no-one defends the latter I might just do it myself, on a devils advocate basis of course. I just can’t see how China can get of the dollar assets high-roller myself.

Not now at any rate. Of course in ten years time…………

“Out of interest. Has anybody ever have examined how to leave the Euro?”

No, definitely not.This is clearly a taboo subject. In theory it is impossible. If people stared talking about it, that would already imply it was an active option.

That is why, for example, it is highly significant that some people are even begining to speculate that Italy might leave.

Really all of this puts economists in a very complicated ethical position. You see, even mentioning it, you can be accused of encouraging it. The whole game, and it is a game play, is to keep the markets convinced that it is impossible to leave. On the other hand if economists say nothing, then a lot of ordinary decent people get to lose a lot of their money without warning.

If you want to see how the mechanism works you would have to go back to Argentina 2001. Effectively Argentina was in a currency union with the US. Pesos were convertible on a 1:1 basis with dollars and guaranteed by a currency board. If you wanted dollars for your pesos you just had to join the line outside the currency board offices and demand your ’swap’. Of course at the end the queues were enormous.

Now, in the case of Italy, it could be like this.

You choose a bank holiday, and the first indication the average person in the street has is that the bank holiday is extended for the whole week. Actually all the people who follow economics see this coming ages before, but the average person is taken ‘unawares’, they simply can’t imagine it could happen. So much for ‘perfect information and foresight’.

What happens next is some money is quietly printed somewhere. Often forms of near, or scrip money are used. Eg the government can pay its emplyees in iou’s which the shops have no alternative but to accept or they have no customers.

Euro notes are protected, of course. Lets say Italy introduces a New Lira. Then the next Monday you can go to the bank with your euro notes and change them for New Lira: at 2 lira per euro, because of course the whole objective here is to devalue.

Now the trick is the bank accounts, in particular the deposit accounts: they will be converted 1:1 so people find the real value of savings cut in half (this is of course just an example).

There are lots of demonstrations and protests, but effectively people cannot do anything, the money is lost.

The real problem comes with the sovereign debt, which is denominated in euros, and individual indebtedness (eg your mortgage). These cannot be converted 2:1 since Italy would fall into huge debt deflation, but if they are converted 1:1 the banking system goes bust, and the foreign holders of government debt are threatening the Italian govt something mighty.

So you have a long lasting ‘negotiating period’.

OK this was just a review, a hypothetical one. Do I think it could happen in reality: a definite yes.

Many have argued that this is an artifact Asian central banks have created. Wouldn’t they scale back on buying dollars?

Germany depends on exports

So you neither want a sudden upwards correction as a result of an unexpected YES? I guess you can’t have it both ways.

Fits Bolkestein has said he would not have backed the introduction of the euro had he known France and Germany were going to ignore the stability pact that underpins the currency.

Out of interest. Has anybody ever have examined how to leave the Euro? I mean in a mechanical way, the old banknotes are gone. Also you hardly can do a public discussion or even a secret discussion of this in government. Once something leaks you’ve killed the currency whatever you’d have decided otherwise.

I think it is important to note that I am trying to argue that the euro is ‘overvalued’. I have been arguing this consistently since 2002, here and in other places (afoe didn’t exist in 2002 :)).

What the ‘real’ value of the euro is is hard to say. Stephen Jen at Morgan Stanley suggest 1:1 euro/USD. That sounds about right. The problem is made more difficult by the artificial rise in the dollar 1995 - 2000 induced by the internet bubble.

But if we look at the comparative growth and inflation rates of the US and German economies 1995 - 2005 then something like 1:1 wouldn’t be a bad guess.

So I am arguing the euro needs to come down: YES.

So that means that a ‘no’ on Sunday will be a good things, well, NO. And for *two* principle reasons.

Here’s the first one, which European readers will find hard to appreciate. A rapid decline in the euro will put a lot of strain on the dollar, on the US current account deficit (although this depends on what happens as a consequence to a broader range of currencies), and on the US disinflation process. It can also, if accompanied by a drop in ECB rates, make it difficult for the US Fed to raise rates, and this can fuel even more the US housing boom.

Why should Europeans worry about this: simply put because Germany depends on exports. The US-China conveyer belt is driving global growth, and anything which upsets this - like growing protectionism and anti-China sentiment (the US has its China, and the EU has its Turkey) - can unhinge everything. We need to tread very carefully, since we are, at the end of the day, all locked together. This is what globalisation implies. So we should be worried about anything which can harm global confidence, and global growth.

Which brings me to the second argument on why a ‘no’ on Sunday won’t be good news: an orderly reduction on our part, with the ECB with its hand on the tiller, would be no bad thing. But if we drop suddenly, because of a loss of confidence, this will definitely be negative, and undoubtedly produce all sorts of internal debates which it might be better not to have just in this moment:

eg Fits Bolkestein has said he would not have backed the introduction of the euro had he known France and Germany were going to ignore the stability pact that underpins the currency.

“If I had known then what I know now, I would not have advised my party [VVD] to vote for the currency”.

In the coming days we are likely to see more of this.