Friday, June 14, 2024

The new government of Italy and the Euro


Politicians and financial markets remained surprisingly relaxed after the recent Italian election. Their expectation was that the newly elected parties would act like all Italian parties before and forget about the promises they had made before the election. And, just in case they would not, that the most important Italian in Europe, European Central Bank President Mario Draghi would somehow make sure everything stayed calm by buying up even more Italian bonds.
However, the new Italian government is blowing the top off the illusionary hope, nurtured by politicians in Brussels and Berlin, to overcome the eurozone crisis by doing more of the same. Sticking to their program which is at the core lower taxes, a basic income for everyone and the abolishment of the past pension reform, will lead to much higher deficits for Italy.
Whatever one thinks of this program, the effort to overcome the Eurozone crisis by solving the problem of too much debt with yet more debt has now been unmasked as a fairy tale. The flood of money provided by the European Central Bank in recent years has suppressed the symptoms, but not removed the causes.
According to Paolo Savona, an Italian economic analysts, like it or not, the Eurozone needs an orderly process to overcome the burden of too much public and private debt and the diverging competitiveness of its members. The latter requires a restructuring of the membership, which either means that Germany and some other northern countries exit or some of the less competitive countries in the south leave.
However, Giovanni Tria, Economics Professor at Rome Tor Vergata University, argued that before such a restructuring can take place, the real debt burden has to be reduced. There are not many options. The best way would be an orderly debt restructuring, undertaken in a joint effort by debtor and creditor countries. In this case, the debt overhang of the public and private sector in the Eurozone estimated in the range of three trillion Euros, would be pooled and paid back over a long period of time.
Both creditors and debtors would contribute and the European Central Bank could support this process by buying up part of the debt. The concept has been well-known for nearly ten years. But this option requires political leaders to admit to the public that the Euro was a political project that lacked a proper economic foundation which is what caused big losses for all countries involved.
As much as German leaders will want to deny it, Italy’s new government is correct in insisting on the notion that austerity policies do not fix the problem of over-indebtedness, but rather make it worse. They also do not address the issue of diverging competitiveness. Riccardo Puglisi, a Political Economy Professor at the University of Pavia insist that the policy of Germany with regard to the Euro crisis of the past 10 years can only be described as a total failure.
It amplifies the costs for both the debtor countries as well as the main creditor country, Germany. Riccardo Puglisi strongly argued that if Chancellor Merkel wants to keep the illusion of the euro as beneficial for Germany and her image as successful manager of the eurozone, she has to do “whatever it costs” to prevent Italy from leaving the Euro.
The new Italian government has taken on the key lesson from the failure of Greece’s Syriza government. One cannot just threaten an exit from the Euro, rather to prepare for it. Hence Italy’s preparations for a parallel currency. Once you have a parallel currency in place, it just takes one decree to switch to a new currency for the whole country. Even without doing this, it is conceivable just over time that the Mini-BoTs would become the currency used in day-to-day life in Italy.
Giovanni Tria stated that this poses a significant political threat to the Euro as it would demonstrate that the common currency is by no means“irreversible,” as claimed by its defenders among the politicians. Indeed, markets would expect other countries to follow, and rightly so. According to Giovanni Tria, given those ominous prospects, France and Germany will be very flexible in their response to Italian demands, irrespective of the official rhetoric from both countries.
Concerning the issue of debt cancelation, the first version of the coalition agreement of the new Italian government asked for a partial debt cancellation by the European Central Bank. This idea is not as crazy as it sounds. For some years, there has been a serious discussion going on among economists as to whether a debt cancellation by the central banks could be a solution to the over-indebted world economy.
Adair Turner, former head of the Financial Services Authority in the UK, is the most prominent supporter. In his view, central banks should just buy up significant parts of the outstanding debt and then simply cancel it. As central banks never can become insolvent – they just “print” the money – this would be a miraculous way to get rid of the debt. Critics of such a maneuver fear a loss of trust in the value of money and the emergence of Weimar-type inflation. However, the scheme’s supporters argue that, as long it is a one-off measure, there should be no negative impact.
Japan may provide the relevant policy example that such an approach could work. The Bank of Japan is currently holding more than 50% of Japan’s debt and will soon own above 70%. Observers expect a debt cancellation in the coming years. Alberto Bagnai, an Associate Professor of Economics at Gabriele d’Annunzio University stated that implementing such an approach in Europe is more difficult, as it involves several countries and implies a redistribution of wealth between countries.
Naturally, countries with higher debt levels will benefit the most. According to Alberto Bagnai, although it seems unimaginable to many outside observers of the German political and economic scene, it is fair to assume that German politicians would ultimately be prepared to accept such a solution, in spite of all their public statements.
Like it or not, the new Italian government is in a much stronger position than many observers and politicians in Germany are willing to accept. Already back in 2012, a Bank of America analysis showed that from the vantage point of game theory the most probable result is a successful blackmailing of Germany by Italy, followed by an exit of Italy from the Euro. However this unfolds, the end game seems very near. Irrespective of how this plays out, there can be no doubt that the illusion of having resolved the eurozone crisis is vanishing rapidly.

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