The Corner

Rubble for No Good Cause

Writing in the Daily Telegraph, Ambrose Evans-Pritchard makes the case for an Italian departure from the the euro. He describes the country’s savage deflationary crunch (the Italian employers’ federation has warned that Italy is being reduced to “social rubble”) and then notes that “Italy already has a primary budget surplus [that’s the surplus before interest payments on the country’s debt]. This will rise to 3.6pc of GDP this year, and 4.9pc next year::

This is by far the “best” fiscal profile in the G7 bloc, yet it is a pyrrhic achievement. The recessionary effects are overwhelming the gains. The debt is accelerating upwards. The industrial structure of the country is being bled white….

Personally, I was stunned by the level of bitterness on a trip to Rome three weeks ago. One senior official – a long-standing supporter of EMU, and one of its custodians – told me the euro was “basically dead”. Barely 30pc of Italians now think the euro has been a “good idea” (Pew Trust). They certainly have good reason to feel aggrieved. Italy is not fundamentally a basket case. It has been turned into a basket case by the perverse mechanisms of the euro itself.

Combined public and private debt is 260pc of GDP, similar to Germany and much lower than in France, Spain, the Netherlands, Denmark, the UK, the US or Japan. With private wealth of €8.6 trillion, Italians are richer per capita than Germans. Italy scores top on the IMF’s long-term debt sustainability indicator at 4.1, ahead of Germany 4.6, France 7.9, the UK 13.3, Japan 14.3, and the US 17. It is one of the very few countries that has sorted out its pension crisis [if I may say so, that overstates it, but as the badly battered esodati can testify, tough pension reforms have been introduced].

Their one big problem is that they are in the wrong currency.

As we all know by now, they have lost 30pc or so in unit labour cost competitiveness against Germany since the launch of EMU because of the slow ratchet effect of wage inflation and poor productivity growth. The damage has been done. You cannot set the clock back. Italy’s historic trade surplus with Germany has switched into a big structural deficit, locked in permanently by the effects of EMU. They have little hope of clawing back the lost ground through wage deflation and an “internal devaluation” since that will play further havoc with debt dynamics, if it does not lead to street revolution first.

But could Italy make a break for the uscita?

The country’s primary surplus implies that it can leave EMU at any moment of its choosing (unlike Greece, Spain, or Portugal), and it is big enough to go it alone. Its international investment position is only slightly negative (unlike Spain, in the red to the tune of 92pc of GDP). Italy’s very high savings rate and private wealth mean that any interest rate shock would mostly be rotated back into the economy in higher payments to Italian bondholders. The macro-effects would even out. Nor do I accept the usual mantra that Italy’s interest rates would soar post-exit. They have already soared in real terms (even if they are lower today in nominal terms than during the lira days). Indeed, a counter case can be made that the only way for Italy to bring down its real borrowing costs at this stage is to leave the euro immediately.

Italians will of course decide their own destiny.

If they are given the chance. That’s not the usual euro-zone way.

I suspect that Mr. Evans-Pritchard underestimates the problems the country would face on the way out. To start with, if there were any signs that Italy really was headed for the exit, there would be a colossal run on the country’s banks (a return to the lira might be good for Italy over the longer term, but it would be terrible for any depositors who found their euros turned into lire) with who knows what consequences.

Nevertheless, food for thought.


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