Edward Hugh on the Italian runaway train

by on August 18, 2014 at 1:39 am in Current Affairs, Economics, Uncategorized | Permalink

Here is one bit:

 The combination of low inflation and low growth means that it is the evolution of nominal GDP that really matters now. Nominal GDP is non inflation corrected GDP (or GDP at current rather than constant prices). If inflation remains low or even becomes negative, then nominal GDP will hardly increase and may even continue to contract (as has happened in Japan). The result is bound to be that the gross government debt to GDP ratio rises above the 135.6% it hit in March.

One of the arguments frequently advanced about how this dynamic could be turned around would be for Italy to run a “large” primary budget surplus. Now the emphasis here is on large since the country has in fact run a primary surplus (income – expenditure before paying debt interest) since the early 1990s, but that hasn’t stopped the weight of the debt climbing and climbing.

The full post is here, scary throughout.

Realist August 18, 2014 at 2:07 am

Italy needs more immigrants, bc lowering average human capital and sociql cohesian is good!!

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Anon. August 18, 2014 at 4:32 am

>bc lowering average human capital and sociql cohesian is good!!

It seems to have worked out well for the Americans, no?

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Randy McDonald August 18, 2014 at 9:17 pm

Italy had high national social cohesion to start with?

More to the point, if Italy’s native talent and workforce is leaving, what else is Italy to do if it is to survive but import it?

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Peter Schaeffer August 18, 2014 at 2:22 am

Italy is at risk of defaulting (in some manner) eventually. Clearly some alarmists predict some sort of crisis in 2015. Not likely. In 2025 the issues may be mostly unchanged.

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prior_approval August 18, 2014 at 2:27 am

Eurogeddon – always fresh, and always scary.

Escpecially when one reads about things like this, from the socialist/environmentalist hell hole that is Germany –

‘ Germany reduced its roughly 2 trillion euros of public debt last year for the first time since post-war records began in 1950, helped by the reduction of toxic assets in government-run bad banks, the Statistics Office said on Thursday.

The combined debts of the federal government, the 16 federal states and local authorities plus social security fell by 1.5 percent, or 30.3 billion euros. That leaves the overall debt burden in Europe’s biggest economy at 2.04 trillion euros.

The strongest decrease, 5.2 percent, was in the area of social security, said the Statistics Office.

Federal and state government debts had been eased because toxic assets that came from state-owned banks Hypo Real Estate and WestLB were off-loaded. These assets were parked in so-called bad banks during the global financial crisis.

At the federal level, Germany is aiming to have no new borrowing next year. Low employment and steady growth have generated record tax revenues while rock-bottom interest rates have reduced the burden of servicing Germany’s 1.3 trillion euros of federal debt.’ http://in.reuters.com/article/2014/08/14/germany-economy-debt-idINL6N0QK1PN20140814

Strangely, one does not read much of a country that has a heavily unionized manufacturing economy subject to extremely stringent environmental and safety regulations, and the crippling burdens that country’s economy faces due to such handicaps.

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andrew' August 18, 2014 at 2:45 am

Funny, because I got the impression this is all u have ever seen on the topic.

How are you guys still sore about no one giving you props respek?

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Daniel August 18, 2014 at 5:08 am

Good for Germany.

Now please, enlighten us – how exactly is Italy supposed to achieve the same result when the ECB (which the Germans run) are denying them the necessary growth ?

Moron.

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Peter Schaeffer August 18, 2014 at 10:11 am

PA,

What will Germany’s finances look like after Italy defaults, devalues, leaves the Euro, etc.?

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Peter Schaeffer August 18, 2014 at 10:28 am

A few years ago, Michael Lewis wrote a funny article about Germany and finance (see “It’s the Economy, Dummkopf!” in Vanity Fair). The article has been (correctly) criticized for all of its social and cultural baggage. However, the core economic point of the article was and remains valid. Germany may have been sober and serious in its domestic economic policies. However, Germany’s foreign economic policies (reckless Club Med lending) were anything but.

These countries (Spain, Italy, Greece, Portugal, etc.) will default over time (Greece already has) one way or another.

How much of the cost of these defaults will end up as German public debt? A lot it would appear.

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ChrisA August 18, 2014 at 3:28 am

Italian households still are fairly wealthy, in fact the median household is several times wealthier than the German one.

http://www.voxeu.org/article/are-germans-really-poorer-spaniards-italians-and-greeks

In addition, a lot of Italians have a lifestyle that doesn’t demand a lot of money. This is especially true of the older generations, who grew up in greater poverty and thus know how to live cheaply.

So this “crisis” can continue for a long time. As Adam Smith said “there is a great deal of ruin in a Nation”.

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Art Deco August 18, 2014 at 12:29 pm

in fact the median household is several times wealthier than the German one.

Several times? That’s a neat trick considering that per capita income is higher in Germany.

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Apeman August 18, 2014 at 6:19 pm

Wealth is bogus measure. That is why income is used more often. You don’t really know how wealthy you are until you try to turn your wealth into income.

The fact is Italians are more likely to own their houses while Germans are more likely to be renters. The houses that the Italians own will be hard to turn en mass into income at the rate they are currently valued at.

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ChrisA August 19, 2014 at 7:00 am

Houses don’t have to be sold to add to income, basically you can live rent free, which increases your disposal income. And generally speaking I would guess that measures of wealth are usually on the lowside – people tend to have assets that are not necessarily on a government register. I would guess this is more true of Italy than Germany.

In any event, I would rather be poor in Italy than in Germany, if only for the weather and the cuisine.

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Apeman August 19, 2014 at 11:33 am

Income is measured on the low side as well. Perhaps I am more sensitive to that then I should be (having worked in the building trades) but it is on those grounds that would argue if I was inclined to prove that Italy was wealthier than it seemed. Last time I saw an estimate, Italy’s (and indeed all Mediterranean countries) had a much larger grey market than Germany.

But to get to your point, I did not mean that the concept of wealth is bogus. I just meant that measuring wealth apart from income is a dubious idea. I believe that Warren Buffet is a wealthy man because the business he owns throw off lots of cash, not because of what his share prices are doing at any given movement. I will grant you that a lot Italians do not have to pay rent but that does not make as much difference as you think. The difference between renting and having to make all the repairs and tax payments yourself does not make for a whole lot of difference. So I do not believe any “wealth” figures that try to prove they are better off even though “income” figures show otherwise. If wealth does not throw off income, its status as wealth is questionable.

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Tom August 18, 2014 at 6:00 am

Italy’s debt is compounding quickly not because of low inflation, but because it is running significant deficits despite its creditors demanding high real returns to compensate for the high risk of restructuring. Italy’s real sovereign bond rates are much higher than Japan’s.

Any way you slice it, Italy needs real growth, or else it will face austerity in some form or another. If you think all of Italy’s public spending is absolutely crucial to support long-term growth, then they’re doing the best they can but it’s not enough. If you think Italy could improve its fiscal balance without much pain or growth impact, then Italy is irresponsibly forestalling needed austerity and stumbling towards crisis.

For the near term Italy will have a kind of creeping austerity in the form of a growing share of the national budget committed to paying interest, leaving less for other kinds of public spending and probably somewhat reducing consumer spending (transfering money from spendier taxpayers to thriftier bondholders) and worsening the current account (paying more interest to foreigners). Unless growth revives, there will have to be a reckoning at some point, probably a mix of sudden, harsh austerity and restructuring.

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ThomasH August 18, 2014 at 7:07 am

A better solution would be a change in ECB policy to target ngdp growth of say 5%. Failing that, it might actually target inflation and take steps to insure it does not fall below 2%

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Tom August 18, 2014 at 9:49 am

Central banks have no power to regulate NGDP. What you’re really asking for is fiscal stimulus.

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ThomasH August 18, 2014 at 12:35 pm

Scott Simon, call your office.

Do you think central bank purchases of anything but short term government paper is “fiscal policy?”

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Tom August 18, 2014 at 3:57 pm

no, though you could call some of it quasi-fiscal. eg buying agencies. it’s also ineffective to barely effective in boosting spending, not nearly enough so to regulate ngdp. if you believe public authority should regulate ngdp, you can only achieve that through fiscal policy. you need to understand which part of public authority spends.

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Art Deco August 18, 2014 at 9:24 am

Time to re-introduce the lira and devalue.

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Peter Schaeffer August 18, 2014 at 10:09 am

AD,

+1

If you look at the long-term trajectory of Italian national debt, Italy started the post-WWII period with low levels of indebtedness. Apparently, that was a consequence of high inflation in the war period. Using inflation to shrink out public debt isn’t the sort of policy that comes highly recommended. However, it works better in practice than in theory.

Note that the U.S. also reduced its post-WWII debt with inflation. The CPI was 48% higher in 1952 than it was in 1945. Of course, the U.S. also enjoyed fast real economic growth and budget surpluses. Real GDP fell from 1945 (2.215 billion in 2009 dollars) to 1946 (1.959 billion) as war production ended, but then grew to 2.454 billion in 1952. The peak 1946-1952 surplus was in 1948 (11.796 billion). A useful converse point is that America paid its post-Civil War debt in gold during a time of deflation (the detail are more complex but don’t change synopsis).

Devaluation would slash Italy’s public debt in an instant (presuming it was redonominated in Lira). Of course, Lira redonomination would trigger huge banking crises across Europe.

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Art Deco August 18, 2014 at 12:23 pm

Of course, Lira redonomination would trigger huge banking crises across Europe.

No, their external debt would remain denominated in Euros. The utility of devaluation would be the enhancement of competitiveness. You could institute exchange controls to inhibit capital flight (say, monthly auctions of tranches of foreign currency) and take a few days at the beginning to sort the vault cash in the banks. Each country’s coinage has a signature design and domestically printed Euronotes can be identified and differentiated from those printed abroad by an alphabetic code on the back. Barry Eichengreen was insisting the preparation time would make a re-introduction of national currencies impossible, but it was done in a few days when Slovakia seceded from Czechoslovakia.

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Just Saying August 19, 2014 at 7:08 am

Pretty sure there would be huge banking crises triggered across Europe even if the existing debt wasn’t redenominated, as rightly or wrongly most holders would assume the worst for their repayment prospects and the price of Italy’s EUR debt would get hammered….

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Art Deco August 19, 2014 at 1:21 pm

Which non-Italian banks are major holders of Italian debt securities?

Art Deco August 18, 2014 at 12:26 pm

If I’m not mistaken, Italy’s public debt is largely held domestically.

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ThomasH August 18, 2014 at 12:38 pm

Too bad they were not fortunate enough to have Mr Soros to do them the favor he did the UK and strangle the Euro before it swallowed the lira.

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Donald Pretari August 18, 2014 at 1:30 pm

” It makes assumptions regarding interest rates, growth rates and related variables, and computes the cyclically adjusted primary budget surplus (the surplus exclusive of interest payments) consistent with this scenario. As they point out, the heavier the debt, the higher the interest rate and the slower the growth rate, the larger the requisite surplus. In fact they found that the average primary surplus required in the decade 2020-2030 was 5.6% for Ireland, 6.6% for Italy, 5.9% for Portugal, 4.0% for Spain, and 7.2% for Greece.

Is it plausible that Italy could run an average primary surplus of 6.6% of GDP over a decade? Hardly – in particular this implies that on average, every year, the government would be draining out 6.6% of GDP from domestic demand via taxation. Yet as I have noted many times, domestic demand is precisely the weak point in the Italian economy (secular stagnation, ageing population).”

The key here is to fudge the assumptions to make the plan palatable, if not really digestible. This is a matter of advertising, not economics.

“But the problem Italy has at the moment is one of the credibility of its debt, of the country being able to convincingly argue its trajectory is sustainable, of being able to convince the Germans that if the ECB were to buy bonds these they could EVER be redeemed.”

It is not a question of convincing the Germans, since G-d couldn’t do that. It’s a matter of making all the other choices dealing with the near future so repugnant that rolling a set of loaded dice, snake eyes likely, will be worth it by deferring the cost till the uncharted future. Surely this is the clear choice under any rational assessment.

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