Italy and the euro: On the edge

http://www.economist.com/node/18958397

by llambda • 15 years ago

141 105 15 years ago

Derbasti2• 15 years ago

At some point, we will have to realize that debts are a bad thing. No one can spend money he does not own without paying the consequences. The Euro seems to be exacerbating this race towards a tipping point.

It seems that some kind of serious crash is inevitable. But it is yet to be seen whether Europe (and the world) will come out of this united or in flames.

thingie• 15 years ago

Is there some concept of money that doesn't (almost) directly link money to debt? (so money wouldn't be completely worthless without debt)

onemoreact• 15 years ago

While the demand for most moderen currency is based around Taxes and Debt you can also link them to a wide range of real or vertual goods. AKA gold in an MMO or Mooncakes in china. (http://marketplace.publicradio.org/display/web/2010/09/21/a-...)

Edit: Bit coin is an interesting experement with the idea that simply because something is finite it has value based around the idea that at some point people might want it. Even the most simplistic analysis suggests the market will quickly become prone to bubbles but what's intresting is how it will recover after a major crash.

PS: I don't know why people ignore the link between Taxes and Money but try paying your taxes in gold bullion and see how far you get.

carsongross8• 15 years ago

Yes.

It was called the gold standard. It worked quite well for a very long time.

No respectable academic economist takes it seriously.

Which is why you should.

uvdiv5• 15 years ago

Yes, commodity money. A commodity has intrinsic value; so if you use commodities as money (medium of exchange, store of value...), you have money with intrinsic worth.

Supposedly it's the original money, since it arises spontaneously in a barter system. Suppose you have a matching problem in a barter system (I want X from A, and A wants Y, but I only have Z...) The way to solve it is with a series of intermediate barters which cancel out, whose only purpose is to coordinate exchanges (I first give Z to B in exchange for Y, which I then trade for X with A). Some commodities are better at being intermediates than others: they have to be persistent, subdividable, popular (so it's easy to find counterparties who want it). So you have several commodities which end up universally used as exchange.

adw2• 15 years ago

Debt is a mechanism for moving risk around - risk-averse parties (the people taking the loan) selling risk to risk-seeking parties (the lender). You're buying money now and paying interest, providing return, against which there's a chance it doesn't get paid back.

As such, there's actually not much of a difference between debt, insurance, and synthetic derivatives such as credit default swaps. (Modern debt and insurance practice both originate from the shipping industry.)

Of course, if you believe the world's a better place without corporate finance, you're entitled to think so, but we'll have to disagree.

Derbasti2• 15 years ago

That is a very interesting thought. Thank you for mentioning it!

uvdiv5• 15 years ago

Debt is a mechanism for moving risk around

Much more fundamentally, it is a mechanism for moving things around -- tangible capital like tools and buildings. Interest is in part a payment for risk of default, but it is also payment for use of capital (the debtor gets to use it, the creditor gives up his ability to use it). There would still be interest even if there were no risk at all.

carsongross8• 15 years ago

Am I allowed to think that the world would be a better place without implicitly and explicitly publicly backed private corporate finance?

Just want to make sure that'd be OK.

iwwr• 15 years ago

Only exacerbated because the ECB is not a central bank in the traditional sense. Traditionally, the central bank (or a related institution) would just print up money to make up for the shortfall. The logic of modern politics leads inevitably to the printing press.

Now, the only way the Germans would have agreed to an ECB would have been a bank at least as strong (and printing-averse) as the Bundesbank. So the so-called 'stability pact' was signed in order to placate them (max 3% of GDP deficits and max 60% debt to GDP ratio, working toward zero deficits at some point).

What happened was the Euro states continued or increased their spending, producing deficits even during the great boom years right before the collapse. Today, the Stability Pact is a dead letter and members (the PIIGS in particular) are trapped without an ability to print themselves out of trouble. Of course, the ECB has been issuing a lot of new money, but just to rescue the major banks, the governments are on their own.

This isn't to say that it's a good idea to print oneself out of debt, but governments find it the easiest thing to do. The crisis would not exist if expenses could have been scaled down as easily as they have been increased. It's better in the end to have a strong currency and balanced budgets, but balanced without low expenditures, not high taxes.

lkrubner• 15 years ago

People who make arguments against debt are ignoring a great deal of historical information. A person, or a nation, can clearly spend money on stupid things, but that doesn't mean that debt is bad. Many businesses take on debt to grow, or at least they seek a credit line to cushion themselves against variations in income.

The argument for debt goes like this: in the future "we" will be wealthier, so why don't we borrow against our future income to make the investments that will ensure that, in fact, in the future we will be wealthier.

"We" can refer to a person, business, or nation.

The careful and strategic use of debt has been used to build great empires. A quote:

http://www.ukpublicspending.co.uk/debt_brief.php

"Chart 2 tells, in stark detail, the story of the British Empire. It was built on the National Debt. Throughout the 18th century the National Debt grew and grew, from nothing at the end of the 17th century to about 60 percent of GDP by the end of the War of Spanish Succession in 1715."

To win World War II, the USA drove up debt to 100% of GDP, a level much higher than what it faces today.

To finance business, an interesting difference has developed between the English speaking nations (I mean those who inherit their legal codes from English Common Law) and those nations of continental Europe. In the English speaking nations, it became common, by the 1800s, to finance growth by offering equity for sale at public auction. The continental nations developed along different lines -- banks played a larger role. In Germany, most firms operate with higher levels of debt that what would seem normal in English speaking nations.

To get an understanding of the importance of debt, and its history, I'd suggest you read Fernand Braudel:

http://www.amazon.com/Wheels-Commerce-Civilization-Capitalis...

As he points out, debt and civilization tend to go hand in hand. Debt was illegal in many European nations during the Dark Ages. Nations in the Mideast and India all had flourishing markets in debt, and flourishing trade, while Europe was sunk in poverty. When Europe revived and began to expand again, it helped itself along with the revival of credit, and credit markets. By the time the 1600s came around, Amsterdam was able to offer the world the full range of modern financial instruments: put and short and forward contracts, options of every kind (save for the exotic derivatives of recent vintage).

There is no civilization without debt, no advanced commerce without debt, no growth without debt. The wheels of commerce are greased with credit.

spydum• 15 years ago

Yes, debt makes sense when talking of investment. However, borrowing is a bad choice when you are just trying to pay operating expenses. This is the dilema: nations have shifted from borrowing for investment purposes, to borrowing to keep the lights on.

scythe2• 15 years ago

>"Throughout the 18th century the National Debt grew and grew, from nothing at the end of the 17th century to about 60 percent of GDP by the end of the War of Spanish Succession in 1715."

That's a fifteen-year period, not throughout the 18th century, and for that entire period, England was at war. It's absolutely true: debts help win wars. This isn't surprising: war is one of those times when there's a good argument for borrowing against the future, because the alternative is annihilation. On the other hand, during most periods of peace, historically, debt as a percent of GDP has fallen.

http://en.wikipedia.org/wiki/File:US_Federal_Debt_as_Percent...

The thing is we don't have any more wars worth fighting. Maybe in twenty years the precarious situation of "the largest economy in the world is totalitarian [i.e. China]" will boil over, but that definitely isn't happening any time soon. These days, we just accrue debt for no reason, or to fight a war on nothing (drugs, terror, cancer, tobacco).

Debt by country:

http://en.wikipedia.org/wiki/File:Public_debt_percent_gdp_wo...

Growth by country:

http://en.wikipedia.org/wiki/File:GDP_real_growth_rate_CIA_F...

(I wanted to say something about this but I'm having trouble distinguishing between five identical shades of green)

craftsman• 15 years ago

The Braudel book looks really fascinating. Is it understandable on its own, without having read volumes one and two?

nhaehnle4• 15 years ago

From a purely accounting perspective, debt and money are just two sides of the same coin. Every financial asset you own, whether it is paper money or a number in a bank account, is somebody else's liability.

With this in mind, it is clear that blanket statements like "debts are a bad thing" are useless. Bad with respect to what?

For example, when citizens save some amount of their income in government bonds to have some buffer to protect them against future individual troubles, then can you honestly say that this debt is a bad thing?

The problem of the Eurozone is that there is no fiscally sovereign government which can safely (and in a politically legitimised fashion) carry an unlimited amount of debt.

rrc2• 15 years ago

> Every financial asset you own, whether it is paper money or a number in a bank account, is somebody else's liability.

Gold is a form of money with no counterparty risk; if I own gold it's nobody's liability.

One complication is that some central bankers and governments try to suppress gold being used as money through enforcement of fiat money monopolies at gunpoint...

Edit: I am incorrect in saying gold is a financial asset.

jerf• 15 years ago

As people are pointing out in replies, debts are bad is probably not the right answer. However, debts are much more dangerous than our current analyses are telling us does seem like an inevitable correction. Debt calculations based on smooth probability distributions underestimate Black Swans, and the evidence of this has been pretty clear for a while, it's just that if you give our highly intelligent financial analysts five to ten years of clear sailing, they'll talk themselves into forgetting it again. For various reasons, this is probably not a solvable problem. (Mostly because, during the periods of clear sailing, underestimating risk means you make more money, and over time simple greed will cause more people to do that, until... kaboom. In a way the problem is that we don't have enough crises.)

jbert• 15 years ago

This has always been my perception.

I think that the market forces an underestimation of risk as the only viable long-term strategy (ironically).

If I can run my finance house on a "I will blow up on a once-every-5-year event" I will outgrow a business running on "I will blow up on a once-every-50-year event". So I outcompete my competitors and acquire them or steal their best employees with high salary etc.

Basically, short-termism seems to be the optimal solution in the game theory of risk management.

(Of course, the real problem is the frequency of such events is poorly understood. What happens is that a finance house pursues a 'more profitable' course without perhaps fully understanding their increased exposure. See Taleb, sub-prime crash etc)

tybris• 15 years ago

All of that is true if you don't consider inflation and the money supply. Then stuff gets complicated.

kahawe• 15 years ago

More dangerous than debt is a political system which accepts broke countries into a monetary union when these countries just downright faked their economic statistics and noone did any due-diligence or found out only until years later when it was too late.

retube2• 15 years ago

>They cannot agree on who should bear the cost of today’s crisis: should it be creditors (through a write-down), debtors (through austerity) or the Germans (through transfers to the south)?

In theory it should, of course, be the creditors. You buy an asset (govt bonds), you're implicitly and knowingly shouldering a risk of default. The institutions that bought these assets should have known what they were buying. Caveat Emptor.

Of course in practice you need to ask what the wider implications of default are. Greece _should_ be allowed to default. Absurd austerity budgets are penalising the average Greek whilst minimising the bottom line impact to (arguably wealthy and powerful) European banks. It's no wonder they're pissed. The short-sharp shock of a Greek default will be over in no time. Rolling debt and refinancing terms etc etc is likely to make things worse in the long term.

But of course Italy is different, given the size of the economy. The impact of a default is likely to be far, far wider than a write-down to the creditors. But to be honest I think this worry over contagion is being over-blown. Markets often over-react. It only takes a single hedge-fund these days to move a market - even a big one like Italy debt. It's probably just Bluecrest or Moore selling the market :)

reirob4• 15 years ago

Who knows, maybe Greece is about to get as much money as they can from the EU in order to default after? What would happen in this case?

yequalsx2• 15 years ago

I believe that the money lent to Greece is just being funneled back to banks to pay their existing debt obligations. The so called bailout for Greece is really a bailout for banks. Everyone knows Greece will never pay back these loans. The hope of the ECB is that a Greek default can be pushed long enough into the future so that when it does default the banks will be in better financial shape. The fear is that right now the banking system can't handle a Greek default.

samlevine• 15 years ago

>In theory it should, of course, be the creditors. You buy an asset (govt bonds), you're implicitly and knowingly shouldering a risk of default. The institutions that bought these assets should have known what they were buying. Caveat Emptor.

Indeed. But the reason why you try to avoid a default (or the prospect of one) is that you want to continue to borrow money to finance your deficit spending. Otherwise you get the worst of both worlds: forced austerity and creditors that want nothing to do with you without high interest rates.

retube2• 15 years ago

Yes, absolutely. I was going to add an edit to this effect. Damned if they do, damned if they don't. Anyway the running of these deficits _does_ need to be curbed. It's clear that Greece has been pretty terrible at collecting taxes and managing it's finances. Even now with "Austerity" the UK is still spending £4 for every £3 it earns. Austerity just means "slow the increase in debt". In fact it's prob not even a first-order change, but second order: slow the rate of increase!

Edit: don't know why you've been dv'd, your point is absolutely relevant.

gaius4• 15 years ago

It's not as simple as that. Greece is in a hole largely because tax evasion is the national sport. The "average Greek" should bear the brunt of it. He or she owes decades of back taxes anyway... The premium Greece will have to pay on it's debts won't go away with dropping out of the Euro.

Qz2• 15 years ago

Except that the loans in question were made to the Greek government, not the average Greek. The creditors should have taken into account the Greek government's inability to collect proper taxes.

Let's be honest, tax evasion is pretty much a national pastime in the US too -- the difference is that here the IRS will come after you if you cross the line.

calloc2• 15 years ago

It is not just the tax dodging though. The greek people are, at least in Europe, known for being lazy and many of them are in government positions where they get paid a lot but don't work a lot. That they dodge taxes on top of that is just icing on the cake.

The other issue is that Greece couldn't keep up with exports in terms of cost with other EU member states. It isn't able to keep up with other high export countries for the same goods.

run4yourlives2• 15 years ago

Of course telling creditors to suck it up is a great way of guaranteeing that you'll never see a red cent from them - or their buddies - again.

Pissing off your creditors is like pissing off a business partner - you do so at your own risk; the more powerful the partner, the larger the fall out.

btcoal3• 15 years ago

The problem as I see it, and the article briefly hinted at this is illiquidity. Western Europe is extremely rich (in terms of capital stock) but has a relatively low income (in terms of capital flow) and extremely low income growth. Without structural reforms (improving infrastructure, decreasing frictions in the labor market, reducing entitlements to incentive work, etc) you cannot increase income or income growth levels.

But, by increasing public claims on private wealth and opening the country up to foreign direct investment (read: selling the Sistine Chapel to China to rent) you can tap the capital stock. This should be increasingly seen as a way out for wealthy yet cash-poor Euro countries.

Without structural improvements in the US it will also be the only way forward 30 or 40 years for now. Be prepared for a "Sponsored by India" sticker on the Washington Monument.

r00fus• 15 years ago

Your explanation is a silly mix of right-wing tropes.

You think it's going to be China that buys the Sistine Chapel, or India that purchases the Washington Monument?

No, it will be crony capitalist groups (formulated by the banksters and politically connected) that do so. The fact that these groups may be involved with some sovereign wealth fund of a BRIC or other country is incidental.

Then they'll rent it out at obscene prices and gouge the public further.

btcoal3• 15 years ago

Hmm, well I didn't think this needed clarifying but the internet is notoriously bad at transmitting humor (or maybe I am). But I was being facetious with respect to the examples I gave.

By capturing private wealth, what will most likely happen are taxes on existing wealth (national property taxes, increases in the estate tax, etc.). National debt is uncollateralized and will always be this way, so sovereign debt holders will never have claim to the physical assets of a nation. It is country themselves that can change laws to appropriate private wealth. Constitutions and laws vary in the extent to which this is allowed. There is the notion of an unconstitutional level of taxation in the US.

As for the rest of your ideological rant.

Anyway.

nate_meurer5• 15 years ago

That's interesting. It immediately made me think of the way Chicago sold off its parking meter system in 2009(?) to a private company for a fraction of what it's worth. The deal is so bad for the city, I almost have to believe it was corrupt.

I suspect sales of national assets are unlikely to tap their full value, subject as they are to corruption and to the likelihood that the sellers are over a barrel.

btcoal3• 15 years ago

That was unfortunate. But another side of the issue in Chicago was that the city blew through the cash in record time. Even if the meters had been sold off at an above market price, the disfunction in the local government would have resulted in the squandering of the proceeds.

From your well made point I infer that we should make a dispassionate evaluation of the value of public assets during good times so that they won't be sold for a song during bad times.

Things usually go, "No we will not sell off pieces of our nation" (during good economic times) so nobody actually evaluates the options for doing so --> "We need cash now!" And we become subject to market forces when leveraging public assets.

Gravityloss• 15 years ago

It is also very possible that the average Greek or whatever country person is not responsible for the country's problems.

What we have here is a communications breakdown. So anyone from those countries themselves want to explain what went wrong, when and where?

ez77• 15 years ago

On related news, US and the dollar: On the edge

shin_lao• 15 years ago

The economist likes to predict the end of the euro every six months or so.

Newsflash: countries have armies, banks do not. Guess who will ultimately prevail?

run4yourlives2• 15 years ago

Newsflash: Banks have been prevailing since they were created. Tanks and Guns are nothing against the power of credit.

uvdiv5• 15 years ago

"Newsflash: countries have armies..."

All the Red horses and all the Red men could not put Soviet economy together again.

gvb• 15 years ago

It did provide a really intense story plot, though. http://en.wikipedia.org/wiki/Red_Storm_Rising

nate_meurer5• 15 years ago

Except the conflict is not "countries vs. banks". Big banks and governments are essentially the same entities, and this has been the case throughout history.

Historically, financial crises and disputes haven't often lead to armed conflict.

mcphilip• 15 years ago

If you'd actually read the economist over the past year and a half (i.e. acute phase of euro crisis) you'd know the paper has been a staunch critic of the reactive measures taken by the various parties trying to save the EU and that the paper has not predicted a time frame in which the euro will end; it's only cautioned that current policies are not solving anything and that the crisis will continue to worsen until either it's comprehensively solved or leads to a dramatic breakup of at least part of the currency union.

icarus_drowning• 15 years ago

Look who has the biggest armies in Europe. (Hint: it isn't the countries who look likely to default).

blue12• 15 years ago

actually greece has a pretty big and modern army for its size

Uchikoma• 15 years ago

Italy is nowhere like Greece.

ChuckMcM2• 15 years ago

I enjoy the Economist because they cover topics well and will tell you their sources as well. (which both validates that they have sources and you can evaluate the base information they are using for their article). That being said, this particular event, or series of events, will change the European Union profoundly.

As with most political enterprises, the EU is a compromise. Much like the original Articles of Confederation [1] it took a very touchy situation (pretty much independent political nation-state entities) and attempted to craft a framework around how they might co-operate politically, financially, and militarily.

Early criticism of what was produced was once called 'a bus where every passenger has their own steering wheel' by a Swiss delegate. We can see the literal effects of that as participating countries, have their wheels apparently turned 45 degrees to the direction of travel. If enough countries do that the bus can, and will drive off the road. (ok that's enough torturing of that analogy!)

Europe remembers what it was like to be dominated by Germany involuntarily. One of the sub-themes of the original EU discussions had very real tension about effectively handing over the soverignty to the 'big' economic powers (France, Britain, and Germany). So there were a number of checks and balances in the final treaties that provide very real limits on what the EU can do (mostly they left in the ways to 'help' and took out most of the ways to 'discipline'). That compromise may ulitmately be untenable and the events of the next few years will test those compromises to the breaking point.

I predict several things will be true after this crisis that are not true now. One, I think there will either be a way for the EU to expell a member or to put it under 'federal' control. Second there will be a trans-EU judiciary system which allows for injecting change (either through impeachment, imprisonment, or both) into member states leadership. If such a system existed it would have allowed the joint-EU leadership to demand (and get) corrective action on destructive behavior.

Those changes will effectively mean handing national soverignty over to a central authority. And either the Europeans will be able to swallow that change, or the EU will disintegrate back into independent nations.

It may be that they reach a compromise somehow, but my expectations that the EU will survive unchanged are low.

[1] https://secure.wikimedia.org/wikipedia/en/wiki/Articles_of_C...

enjo• 15 years ago

Can you really see those smaller countries go for that type of language tho? The Irish, Greeks, and Italians (among others) aren't ones to cede anything resembling autonomy.

It would seem the most likely course would simply be the unraveling of many of the treaties that created the EU in the first place.

blue12• 15 years ago

Italians have always been euro-enthusiastic and I don't think they would object to transfer more powers to the EU.

_delirium3• 15 years ago

I don't think bigger countries would go for it either; a referendum in France to hand over any sort of sovereignty to the EU would fail by massive margins.

tomjen3• 15 years ago

The 13 colonies fought a war against a common enemy (Britain) for a relatively short time and did not suffer greatly (compare with Ireland).

Europe countries have been at war with each other on and of (mostly on) at least for a thousand years and while Poland and Russia suffered far more, very few have forgotten what happened to Rotterdam, London and the occupied cities in France.

The horror of the first world war broke one of the most militarized countries in the world (laugh at France all you want, but it was Napoleon who fought Russia). France has never been the same since. It was only a few months ago that they allowed a (tiny) German military base in France.

My maternal grandparents where children during the occupation and was thrown out of their house by the Nazies. To this day they still hate them.

Don't forget the historial rivalries between the UK and France either, though they don't hate each other nearly as much as the French hates the Germans.

Europe is a cross section of old scars and grievances and relative recent wounds that haven't healed all that much; Even the old scars can easily be ripped open.

Europe will never go for what you suggest.

ChuckMcM2• 15 years ago

I completely agree with your assessment.

The worst case outcome I can imagine is that the EU will dissolve, the Euro will be abandoned, and Europe will return to its previous state of decline in terms of competitiveness in the world economic stages. China and India will fill the gap and except for the self supporting economies the rest of Europe will slide into a long and deep depression.

That will be followed by a lot of externalized accusations of conspiracies and general hatred ultimately leading to an insurrection which results in the loss of soverignty for between 1/3 and 1/2 of the current nations.

One 'law' that I've never seen fail is 'Nature abhors a vacuum.' and when the EU collapses, it will create a very, very large vacuum.

pushingbits• 15 years ago

I've lived or spent extensive periods of time in most big European countries (Germany, UK, France, Spain), and there isn't much hate between them anymore. Maybe in the 70+ age bracket you will find some. Then you maybe have some mild distaste from 50-70 year olds, indifference at 35-50 and some appreciation from young people. If you compare German, French and British opinions of each other with their opinions of Turks, North Africans, and Indians respectively it's not even a contest.

That doesn't mean that anyone's going happily hand over their sovereignty, but the picture you are painting of Europe does not fit with my experience at all.

ugh• 15 years ago

The French hate the Germans? So, what makes you believe that crazy nonsense? Wow. How far removed from reality are you?

mslate• 15 years ago

>I predict several things will be true after this crisis that are not true now. One, I think there will either be a way for the EU to expell a member or to put it under 'federal' control. Second there will be a trans-EU judiciary system which allows for injecting change (either through impeachment, imprisonment, or both) into member states leadership. If such a system existed it would have allowed the joint-EU leadership to demand (and get) corrective action on destructive behavior.

I cannot conceive of a country ever allowing others to have impeachment/imprisonment powers over their head of state. This prediction makes absolutely zero sense to me. Much more likely, we may see some member countries leave the union over the next several years.

Jayasimhan• 15 years ago

The image on the article is very creative!

Italy and the euro: On the edge

Related Stories