Last month I had written some posts about the European Union and the Euro, in response to some Eurosceptic triumphalism over the outcomes over the French and Dutch referendums, for both electorates decided against ratifying the proposed European constitution. I took a break from blogging since then , but in the meantime I left two comments at Kim du Toit’s blog when he blogged about this article at the Washington Times. The comments are no longer available at Kim’s archived posts, but I had saved both of them on my hard disk. After the quote from the Washington Times is my first one in a somewhat edited form, the second one isn’t relevant as far as the article is concerned.
Italians, once among the most enthusiastic supporters of a united Europe, are becoming increasingly disillusioned, so much so that some are suggesting that Italy dump the euro and bring back the lira.
Roberto Castelli, the silver-haired Italian justice minister from the Northern League, a major coalition partner in the government of Silvio Berlusconi, said his party will present concrete proposals this week for calling a referendum on ditching the euro.
“Does [the British pound] sterling have no economic foundation because it is outside the euro?” he asked. “Is Denmark living in absolute poverty because it is outside the euro? Are Swedes poor because they are outside the euro?”…
Nevertheless, government economists say privately Italy could gain short-term economic benefits from leaving the euro.
By devaluing its currency, Italy could immediately boost exports, jobs and manufacturing investment. The real value of Italy’s massive public debt, equivalent to some 105 percent of gross domestic product, could be slashed by devaluation.
Kim thought that this would be a good thing, but I respectfully disagreed:
The Italians can’t devalue their currency as long as they have the Euro, that’s true enough. But that isn’t the real problem. The real problem is inflation, for exactly the reason that they played the devaluation game as far as it would go before they took the Liar into the Euro, and then devalued it again by taking the Lira into it as far too low a value.
The result was that on the one hand, Italian products were very cheap when exported, and the resulting foreign demand drove prices in Italy up, for the exported goods were no longer available for Italian consumers. And on the other hand imported goods, and also those resources needed by Italian produces to make their own goods, suddenly also were much more expensive, driving inflation up even more. They are also suffering from horrendously expensive social systems, the most expensive in Europe, which they can’t seem to reform, a problem the can no longer cover up by devaluing.
As a result they now have high inflation, and have to face foreign competitors to their own businesses which aren’t suffering from this problem. Even worse, and even more stupid, the proposed solution to this problem is to take the Lira outside the Euro, and devalue it again. The result will be a new boost to inflation, for devaluation will kick off the same process I described above.
So this solution looks very questionable, but what makes it attractive to (parts of) the Italian government anyway are the scams they would be able to pull off this way :
By devaluing its currency, Italy could immediately boost exports, jobs and manufacturing investment. The real value of Italy’s massive public debt, equivalent to some 105 percent of gross domestic product, could be slashed by devaluation.
(Emphasis mine)
Point is, the money for this massive public debt didn’t come out of thin air, it had to be borrowed from banks and all other financial institutions, and private buyers of Italian state bonds as well. By slashing the real value of the public debt the government would rip off all of these creditors, which had agreed to lend money to it, under the assumption that the Italian currency wouldn’t be devalued again, for that currency would be the Euro. If the creditors had known that the Lira might come back for the express purpose to be devalued, they either wouldn’t have agreed to lend money to the government, or at the very least would have demanded a much higher interest rate, to compensate them for the higher risk of default and the costs of devaluation.
This calculation of the Northern League will, if the scheme were indeed put into practice, backfire big time. It would declare itself untrustworthy for all the world to see, would be taken to all kind of courts and would from now on have to pay a much higher interest rate on that debt, if it hopes to ever borrow money again – even if the value of the principal is slashed, the creditors will want their money’s worth, which means interest payments which will be at least as high as now, slashed value of the principal or not.
I mentioned several scams, the second one are the planned devaluations in another respect: They would benefit politically well-connected businesses in the export sector, while punishing the less-well connected catering to the domestic market and also the consumers, by raising costs and inflation to much higher level than elsewhere in Europe.
The third scam is the high inflation itself, for it leads to an extreme example of cold progression: To compensate for the loss of value of income and liquid assets caused by inflation, wages and interest payments have to be raised – an increase in nominal, but not real value. Trouble is, most countries don’t make any difference between nominal and real value when it comes to taxes, so that you are pushed upwards into a higher tax bracket, without earning more than you did before. This means that higher taxes diminish your income and eat up your property. In other words, the government is nationalizing income and property through the backdoor slowly but surely.
To sum things up, when European governments are complaining about the strain the Euro is putting on their finances, they don’t mean that the common currency is a bad idea economically, they are just bemoaning their reduced powers to defraud. Don’t expect me to spill any tears for them.
Americans have largely forgotten that in the 19th century debates over the currency were the some of the most contentions of the entire era. Like contemporary Europe, America of that era was economically diverse with different potential monetary policies favoring different regions. The fights over the common currency grew brutal at times.
I do think one of the great benefits of the Euro is that it should in principle prevent the kind of monetary shenanigans that politicians who only care about the short term love to get into. Italy should take a look at Mexico if they think playing games with the currency is a good way to get ahead.
I do wonder about the creditors however. If they loan money to Italy in Euros why can’t they demand Euros back? I don’t know how the law works in Italy but normal practice is that debts are serviced in the currency in which they were acquired. The U.S. can’t pay its debts in Pesos for example.
I have argued previously that the EURO is doomed, and nothing that has happened has disabused me of that position. Italy needs to go its own way, as do Germany and France.
Europe is not a single country nor a single culture. the Euro is a bridge too far in the absence of true labor mobility.
I think Shannon has a good point. Italy’s external public debt is Euro-denominated. They would only get to screw their domestic creditors. There is nothing all that unusual about sovereign debt denominated in a foreign currency (google “yankee bonds,” “samurai bonds,” “Brady bonds,” and “eurodollars” for examples).
Any attempt to change the terms of the outstanding debt would rightly be seen as debt repudiation and default. New borrowings would be treated as junk bonds, similar to third-world debt, assuming they could be sold at all.
Italy incurred a lot of that debt when they still had the Lira, so they (or at least the Northern League) think that they can pay it back in devalued Lira.
None of this is very realistic, of course. It seems that they are wanting to leave the Euro, exchanging it back for Lira at the same rate they entered it (1936 Lira for one Euro), then to devalue the Lira by a hefty rate and pay the creditors interest, calculated on the much lower real value of the debt.
As you point out in your comment and I did in my post, this won’t work, except maybe when future Italian bonds are rated as junk.
Because you see, being a sovereign debtor means according to them that you can dictate your terms to private creditors. They are in for a rude awakening. ;)
Italy isn’t the only country suffering from the inflationary effects of the euro, as I posted in my own blog http://mikesbooksandthinks.myblogsite.com/blog/_archives/2005/6/5/910377.html.
The British decision to stay outside and wait has proved, in retrospect, to be one of the smarter decisions of the Labour Government!