Sunday, July 12, 2015
Now - What of Italy?
HUH? What about Italy?
This is really the current burning Euro question. Greece is and has been a foregone conclusion - don't forget the push-down of their private bondholders in 2012. That amounted to somewhere around 100 billion Euros, but in exchange for that, those creditors were promised no further "adjustments". Which of course will be ignored now. They'll get paid in drachmas on a one-to-one exchange. It should spawn a few interesting, but immaterial lawsuits. The only ones left to take the 40% write-down necessary are (snort, snuffle, choke) the other EU governments, who are most certainly not going to want to add to that by extending additional loans while writing down the prior ones. And they are going to get the extant Greek debt added to their debt-loads, but Euro-style, so it probably won't be officially added on for a few years.
(It's like the US debt burden. We all pretend that those student loans that are in income-based repayment schemes not even covering the accruing monthly interest are somehow going to be paid back. But no, the taxpayers are probably out 300 billion on those alone. Extend and pretend is a fine public finance art form.)
But now we come to Italy. Trading Economics has a nice stat site, so we'll use that. As you will note, there is a similarity in the Debt-to-GDP curves:
Greece is the lighter line. The major difference is that Greece has somewhat held the line over the last few years (but remember that write-off of debt in 2012!!!) whereas Italy is quietly trudging up the debt mountain.
As of this writing, both real debt-to-GDP ratios are higher than shown, but Italy's is lower in terms of percent of GDP:
One noteworthy aspect of this is that Italy's debt-to-GDP ratio, hereafter referred to as D-G-r (that's government debt to GDP ratio) is substantially higher than Greece's back in 2010 when the creditors took flight. But Italy has Draghi, doing whatever it takes.
At times, whatever it takes has involved creditors paying Germany for the privilege of holding their bonds. One suspects there is a natural limit to that. After a while opening a trading an account and buying Chinese stocks starts to look better, because at least there's a possible upside.
But what about those Greeks, always running budget deficits??
We have a similar, although less intense, problem in Italy. They are not making progress, and as a result of the current exercise in reality-recognition, sooner or later they are going to get some Greek debt added to their D-G-r, as will all the other European countries. Draghi has already pointedly mentioned that it would be utterly illegal for the ECB to take any of the losses.
Is there really any hope that Italy's debt is sustainable?
In evaluating a country's ability to sustain higher taxes, you generally look at savings rates, which, in the absence of high growth, must go down as taxes go up. Personal savings rates are not available for Greece, but I would bet that they have been higher than Italy's:
Italy's savings rate has fallen so low that it suggests that real bank deposits must slowly fall, which would not help the Italian government in flogging its debt. It's doubtful that they can raise taxes at this point without actually lowering receipts.
Then there's balance of trade - we'll look at the current account to GDP ratios:
There Greece was making progress, but clearly not at a level which would allow it to cut its debt.
Italy has done slightly better:
So there is a grain of hope. Just a grain. With debt at more than 130% of GDP, Italy's current account balance would have to stay quite positive to have a hope of stabilizing debt and then reducing it over the longer term.
If a country's external debt is low, then interest rates on the debt are mostly being recycled back into the domestic economy, and the country can sustain a much larger debt-to-GDP ratio.
There, we see some issues. I suspect that the leg up is due to ECB OMT buying, but I just don't seem to be able to find that information from the ECB. Brueghel is publishing some very nice stats on sovereign debt holdings, but they don't show ECB holdings. According to Brueghel's numbers, peak domestic bank holdings were in Q2 2013 at 24.5%, since dropping to about 22%, and non-resident holdings were slowly rising to 37.9% in Q3 2014, the latest data. That has increased since.
ECB probably will redistribute its profits to the member states, so there could be some offset there.
Well, when in doubt, always look at cash flow. The Bank of Italy publishes plenty of statistics here. We want the financial accounts, which I downloaded and read. A grim awakening.
Here is the grim evidence from Table 15 of their financial accounts, published by Bank of Italy. This is the bottom of the table which covers financial assets and liabilities of the central government (which holds the vast majority of the debt):
On the left we find assets. On the right we find liabilities. This covers Q4 2013 to Q4 2014. Italy's liabilities net assets increased by more than 10%. In a year.
This explains why Italy's sovereign stock increased by more than 10%. In a year:
So, in point of fact only the ability to get ECB to monetize debt is holding Italy on the brink of the abyss (as opposed to being at the bottom of the abyss), because Italy's finances are cartwheeling into doom and there is no prospect of escape from the trap. This debt cannot be absorbed internally and taxes cannot be raised sufficiently to stop the very rapid accumulation of debt.
The moment that Mr. Market realizes that Italy could be next, the King Canute moment is reached.
And this, I think, explains what is happening in Brussels right now - there is no telling what would happen if Greece disappeared from the radar. As long as everyone's staring at Greece, no one's asking the real question.
I suspect, to the degree you could says this is successful, that Italians finding ways around regulations is part of their success.
Thanks for the in-depth analysis.
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