The debate on Euro international and ita
ITACA ECONOMIC STUDIES
IES working paper 23 November 2015
THE DEBATE ON EURO: INTERNATIONAL AND ITALIAN MATTERS
Quirino Biscaro
§ # +
ABSTRACT
In the first phase of the Monetary Union the discussion focused on advantages and disadvantages related to the
Eurozone. The Euro was founded with only three objectives, but absolutely relevant for the member countries: a
uniform growth among States, a strong defense by international economic and financial shocks, the control of the
inflation rate. After 15 years, only the inflation goal was fulfilled; but the Eurozone went even further: now the
problem is deflation, that is damaging as much as, if not more, of a high inflation. The growth of the member
countries is still asymmetric. In the spring and summer of 2011, some bearish operations on government bonds
have put in a corner Italy, Spain, Greece and Portugal. In the winter 2011-2012 Italy was "urged" by the ECB
toward a defined list of actions (to reduce its public debt and to realize some economic and institutional reforms),
because Euro was suffering a great danger. The concerns of the strong Eurozone countries were self-evident,
because a default of Italy would probably have resulted in the end of the Euro (one of the top 10 world's GDP, the
second EU manufacturing, a founding country of EU and Eurozone). This implies that Euro substantially fails the
remaining objective, perhaps the most important one: to defend the member countries from economic and
financial shocks. In fact, it was the Euro that would have to defend the member countries, and not vice versa. As a
consequence, the current debate moves on the convenience to leave the Euro. It must be outlined that in the
financial world there are conflicting opinions, whereas in the scientific world there seems to be a strong
orientation against the Monetary Union, at least in the format in which it is currently conceived.
§ International Trade Academic Center of Advisory
# School of Economics, Languages and Entrepreneurship (Univ. of Venice)
+ Fabbri Foundation
Keywords: Euro, Euro break-up, Monetary Union, ECB, UBS, Bank of America, Merryl Linch
JEL classification: E42, E44, E52, E58
IES working paper
23 November 2015
1
1. THE DEBATE BEFORE THE CURRENT CRISIS
"..... no more borders, no more customs, no more taxes, free trade ..... a continental currency .....
founded on Europe as a whole, with the free activity of two hundred million people as engine."
Victor Hugo, at a banquet in February 1855
At the end of the '90 the common people, the firms and the public authorities were asking themselves several
questions about Euro. The Monetary Union seemed ambivalent as a cure-all for the economy of the member
countries, as well as a bitter medicine that some strong-economy countries have wanted to give to the weakeconomies countries. The opinions were rather divided; they emerged two distinct parties: a base scenario (Eurooptimistic), founded on a strong Euro, and a opposite alternative scenario (Euro-skeptic), based on a weak Euro.
1.1 The base scenario: a strong Euro
The cornerstones of this scenario could be summarized as follows:
‐
‐
‐
‐
‐
a higher degree of cooperation between countries;
a higher resistance to speculation;
a cut (and a stabilization) of the financial costs, with savings in transaction costs;
a more precise planning of the business activity, due to a lower exchange rate fluctuation;
a competitive effect that sooner or later has a positive impact on employment and on the overall economic
growth.
Consequently the Euro-optimistic has foreshadowed that:
‐
‐
‐
‐
‐
in Euro countries starts a policy of fiscal consolidation;
the ECB earns prestige with a moderately restrictive monetary policy;
inflation remains permanently near (not over) 2%;
a institutional conflict between bankers and policy-makers has no reason to exist;
Euro becomes an international reserve currency.
1.2 The alternative scenario: a weak Euro
The supporters of the opposite scenario believed that:
‐ Europe already has a strong currency: the Deutsche Mark;
‐ Maastricht Treaty is founded on a one-way monetary vision of the economy: employment and welfare in
fact they depend on the currency, the only independent variable;
‐ is in itself a sign of weakness the freedom to join or not to Euro;
‐ there is a risk of a two-speed Europe, which in turn implies no Europe;
‐ there is a gray area between the skills of bankers and those of the policy makers;
‐ the ECB has a limited power compared to that typical of a central bank;
‐ in presence of an asymmetric shock, a national central bank can not act alone; without fiscal transfers from
the european central budget the shock would cause a segmentation between countries;
‐ the EU is not an optimal currency area, thus is not suitable for an economic and monetary union.
IES working paper
23 November 2015
2
2. THE EVIDENCE ALONG 15 YEARS
"The Euro should not exist. More specifically, the Euro as it currently constituted, with its current
structure and current membership, should not exist. This Euro creates more economic costs than
benefits for at least some of its members."
Deo, Donovan and Hatheway (2011), pag. 2
The Maastricht Treaty is actually unbalanced on the monetary side of the economy. One of the 5 parameters
of the Treaty is a technical nonsense: it is the well known Debt / GDP ratio, that compares a stock (Debt) and a
flow (GDP), with a devastating threshold (60%). If the banking system adopt it, it would grant a loan of 100,000
euro to those who have a gross income amounting to 167,000 euro !
The feared conflict between the bankers and the policy-makers is a reality.
After 15 year, the expected positive effects for the economy (employment and GDP growth) have took place
only for some Eurozone members: the fears of asymmetric development are materializing.
The ECB does anything than expected institutionally, that is flatten inflation. In fact, from 2011 it implements
monetary actions clearly and exclusively expansive: with the Quantitative Easing it reduces the cost of borrowing
for the Government involved, and it introduces a lot of money into the economic system. On the other hand,
inflation is lowering alone, due to the collapse in aggregate demand. If the ECB doesn't acts as a purely central
bank, is virtually useless.
The origin of the problem is clear: the Eurozone is not, and never has been, an optimal currency area. This is
the necessary condition to any single currency, but it requires compliance with at least one of two specific
features:
‐ the economies of member countries are homogeneous: they move in the same direction, at the same
speed, in the same periods
‐ the economic and social systems are flexibles enough to allow the equalization of asymmetries by
"migration" of labour, wage adjustments, automatic fiscal stabilizers (from the latter comes the Fiscal
Compact)
But it's not just this, although sufficient to explain the difficulties of Euro. There are other relevant factors:
‐ the Monetary Union is literally just monetary, and the Eurozone needs some common social and legal
policies;
‐ the current crisis has outlined the need of North-South policy actions;
‐ the lack of truly common policies allows divergent national policies;
‐ the european policy makers have not realized the threats hidden under some false opportunities: as an
example, the real estate boom of Ireland and Spain which actually turned out to be a speculative bubble.
Perhaps it is not yet the time to declare the Euro failure. However it is certain that the single currency has
failed to defend some member countries from financial shocks: a few bearish operations of about twenty banks
were sufficient to put in a corner 4 Eurozone member states (Greece, Portugal, Spain and Italy).
The difficulties of Euro are self-evident. At the core of the current debate there aren't the advantages for a
country that wants to join the Eurozone, but the costs to bear for a country that instead wants get out of it.
Briefly, the options under valuation are as follows:
‐
‐
‐
‐
the exit from Euro of a weak country;
the exit from Euro of the more competitive country (Germany);
a double Euro: one for the strong countries and one for the others;
the Euro break-up.
IES working paper
23 November 2015
3
About these options a lot of people have something to say, but it is necessary to pay attention to financial and
scientific world. It is also useful the shifting of the debate from the global level to the national level, to be more
specific and to discuss the more troublesome hypothesis among those questioned: the exit of Italy.
3. THE DEBATE WITHIN THE FINANCIAL MARKETS
In this section, the discussion is focused on the possible exit from Euro of Italy. This is an event likely disruptive
for Euro: among the 4 mentioned countries (Italy, Greece, Portugal and Spain), in the Eurozone Italy is the one
having an economic and political level of first magnitude.
3.1 The UBS opinion
Deo, Donovan and Hathaway (2011) states that the exit costs from Euro are dramatic for a weak country, and
still very highs even for a strong country. This implies that the Euro should be maintained even if it is absolutely
necessary to reform it1.
Considering Italy a weak country, the UBS study would assigns the following exit costs:
‐ the default of the public debt if it remains denominated in Euro, due to the inability to recover the
necessary foreign currency;
‐ the default of the public debt also if it becomes denominated in Italian Lira, due to unsustainable increases
in interest rate;
‐ the collapse of the banking system, due to a bank run;
‐ the exit not only from Euro but also from EU;
‐ the exit from EU would be also followed by european protectionist measures that should offset the benefits
of the (obvious) devaluation of the Italian Lira;
‐ some civil unrest, the risk of civil war or dictatorial tendencies;
‐ a fall of the GDP of about 40%-50%.
This scenario is likely for Italy? Anyone can give to himself the answer. Before you do, however, recall that UBS
uses extremes hypotheses: the yardstick is the Argentina at the time of its default. In detail:
‐ a devaluation of the national currency of about 50%-60%;
‐ a loss of about 50% of foreign trade;
‐ the costs of recapitalization of the banking system "transferred" on the depositors.
However, it is quite clear that Italy cannot be compared to Argentina at the time of its default, as it has:
‐
‐
‐
‐
‐
one of the top 10 world's GDP;
the second EU manufacturing;
a trademark that no one else can claim (Made in Italy);
a banking system certainly not among the most advanced but more solid than the argentinian;
a real economy much more diversified; to the manufacturing potential, Italy adds two others positive
factors: the touristic and the historical-cultural ones, as factors of growth unimaginable for Argentina (and
nearly all other countries).
The UBS study is also filled with other critical factors:
‐ the devaluation of the exchange rate is abnormal, if compared to that adopted by others [as an example,
the 11% of Woo and Vamvakidis (2012), the 25% of the french economist J. Sapir, etc];
1
"If the Euro does not work (and it does not), then either the current structure needs to change, or the current membership
need to change." [Deo, Donovan e Hatheway (2011), pag. 2]
IES working paper
23 November 2015
4
‐ protectionist measures envisaged against the outgoing country are possible only in case of exit from EU,
and however should have a unusual size to be able to offset the hypothesized depreciation (50%-60%);
‐ even with such a reaction of EU, it seems overstated to consider that international italian trade "is likely to
be disrupted" [Deo, Donovan and Hatheway (2011), pag. 7]: with the hypothesized devaluation, the Made
in Italy would become much less expensive (a Ferrari 458 basic version now costs about $ 256,000; with
the hypothesized devaluation the equivalent price drops under $ 130,000: it is therefore clear that its
potential market should grows out of proportion].
3.2 The Bank of America & Merryll Lynch opinion
A study of this bank [Woo and Vamvakidis (2012)] argues that an exit from Euro would not induce
unsustainable costs, and develops a scenario of a planned exit. Considering the 11 largest economies in the
Eurozone, the study comes to the surprising conclusion that Italy (together with Ireland) is the country that would
have the greatest incentive to abandon the Euro, given the cost-benefit balance.
This outcome is derived from a 4 steps model. The first is to test the strength in planning the exit from Euro.
On this point the assessment is based on the Primary Balance and on the Current Account Balance, both as a
percentage of GDP. After Germany and Austria, Italy stands at the third place in the ranking (with Netherlands).
The second step concerns the impact on growth. Based on the hypothesized depreciation (11% of the real
exchange rate), the share of exports to GDP and the growth potential (output gap), the study estimates a growth
of 3%. Italy would be second in the ranking (Ireland would be the first).
The third step is the impact on the (real) cost of public debt, for which it is hypothesized a conversion into
national currency. According to an econometric regression between the Standard & Poors country rating, the
nominal cost of 10-year government bonds and the inflation rate, it is shows that Italy surprisingly should benefit
for a reduction in the real cost of public debt of about 20 basis points (- 0.2%). Italy is the fifth country of the
ranking.
Finally, the fourth step is to determine the impact on the overall balance of the country respect of the rest of
the world. Refering to the Net International Investment Position (NIIP), stated by the IMF on the Balance of
Payments, the NIIP to GDP ratio would increase by 15%. In this aspect Italy is the fourth country of the ranking.
The 4 steps imply an overall ranking that push Italy to the first place (tied with Ireland). Therefore it would be
the Eurozone country with the greater convenience for a (planned) exit from Euro.
This scenario is likely for Italy? As with the UBS study, anyone can get a feel. However it is certain that:
‐ the parameters underlying the estimates are more appropriate to the size and nature of the Italian
economy;
‐ the results are derived from the application of a specific quantitative model.
4. THE SCIENTIFIC DEBATE
Many economists are measuring on problems related to Eurozone. Claims and counter claims, assumptions
and thesis abound. It is useful to summarize this complex debate briefly citing the thought of some great
economists. Some of them are facing the Eurozone problems from a general point of view, others specifically
mention the italian problems; the reported phrases were published on Il Sole 24 Ore on 17 December 2013:
1. Milton Friedman (from 31 July 1912 to 16 November 2006; Nobel Prize for Economics in 1976):
"The impetus for the Euro was motivated by politics, not economics. The purpose was to join Germany and France
so closely as to make impossible a European war, and to set the United States of Europe. I believe that the
adoption of Euro will have the opposite effect."
IES working paper
23 November 2015
5
2. James Mirrlees (Cambridge University, Nobel Prize for Economics in 1996):
"I would not to suggest policies to change the current situation ............ However, looking from the outside, I say
that you should not stay in Euro2, but get out of it now."
3. Amartya Sen (Harvard University, Nobel Prize for Economics in 1998):
"The euro was a horrible idea. ..... An error that put the European economy on the wrong track. A single currency is
not a good way to begin to unite Europe. Economic weaknesses lead animosity, rather than strengthen the
reasons for being together. They have a break-effect, rather than a binding one. The Europe doesn't needs the
tensions that have arisen."
4. Joseph Stiglitz (Columbia Business School, Nobel Prize for Economics in 2001):
"This crisis, this is an artificial disaster and essentially has four letters: Euro."
5. Paul Krugman (Princeton University, Nobel Prize for Economics in 2008):
"By adopting Euro, Italy has been reduced to the status of a Third World nation that has to borrow a
foreign currency, with all the damages that this implies."
6. Christopher Pissarides (London School of Economics, Nobel Prize for Economics in 2010):
"The current situation is not sustainable for much longer. It is necessary to abolish the Euro to create the
confidence that the member countries they had each other."
5. A SUMMARY
"I am sure the Euro will oblige us to introduce a new set of economic policy instruments. It is politically
impossible to propose that now. But some day there will be a crisis and new instruments will be created.”
Romano Prodi, EU Commission President, December 2001.
1. In the initial stage of the Monetary Union were discussed advantages and disadvantages for countries that
joined the Euro.
2. The objectives of the single currency were not many, but absolutely relevant for the future of the member
countries: a uniform growth among States, a strong defense by international economic and financial shocks,
the control of the inflation rate.
3. After 15 years, only one of these goals was fulfilled: the control of the inflationary pressures. Eurozone went
even further: now the problem is deflation, that is damaging as much as, if not more, of a high inflation.
4. The growth of the member countries is still asymmetric. This is perhaps the basic reason for the debt crisis of
the so-called PIGS (or PIGSI, as the majority of investors will also includes Italy).
5. The international financial markets, supported by a group of about 20 banks (including Deutsche Bank), in the
spring and summer of 2011 "have took the opportunity" with some bearish operations on government bonds
of PIGSI; a similar situation happened in 1993 against Italy and Great Britain (which were forced out the
European Monetary System)3.
6. In the winter 2011-2012, Italy was "urged" by the ECB toward a defined list of actions (reduction of its public
debt and realization of some economic and institutional reforms), because Euro was suffering a great danger.
The concerns of the strong Eurozone countries were self-evident, because a default of Italy would probably
have resulted in the end of the Euro (one of the top 10 world's GDP, the second EU manufacturing, a founding
country of EU and Eurozone).
2
He refers to Italy.
Banks obviously say that they have not speculated, but had released titles too risky. The facts are well known. As an
example, it is useful to refer to the italian case. Between 2011 and 2013, the changes in the spread between italian
government bonds and the german ones have induced massive sales. Almost always this occurred a few days before the
public auctions of italian bonds, and always the new bonds emissions were entirely placed; it must be outlined that this
happened at lower prices and higher returns than otherwise possible.
3
IES working paper
23 November 2015
6
7. This implies that Euro substantially fails the remaining relevant objective: to defend the member countries
from economic and financial shocks. In fact, it was the Euro that would have to defend the member countries,
and not vice versa.
8. As a consequence, the current debate moves on the convenience to leave the Euro. It must be outlined that in
the financial world there are conflicting opinions, whereas in the scientific world there seems to be a strong
orientation against the Monetary Union, at least in the format in which it is currently conceived.
"Europe was not suited to the single currency, as is the United States. Spain and Florida had the same
real estate bubble. The population of Florida has sought work in other states less affected by the crisis,
but the spanish did not have the same chance." (Paul Krugman, Il Sole 24 Ore, 17 December 2013).
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febbraio
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Online International, 5 agosto
Borghi Aquilini C. (2012) - Cresce l’esercito che dice no all’Euro, Il Giornale, 2 agosto
Bradley J. e Morgenroth E. (2004) - A study of the macroeconomic impact of the reform of EU cohesion policy,
Economic and Social Research Institute, Dublin
Brandsma A., Kancs D., Monfort P. e Rillaers A. (2013) - A dynamic general equilibrium modelling approach to the
evaluation of the EU's regional policies, European Commission, DG Regional Policy wp 1/2013
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D. (2012) - European safe bonds, Princeton University, 2 April
Buiter W., Corsetti G. e Roubini N. (1993) - Excessive deficits: sense and nonsense in the Treaty of Maastricht,
Economic Policy, 1
Corsetti G. (2006) - Monetary policy in heterogeneous currency unions: micro founded reconsideration of the
theory of optimal currency areas, Università Roma III
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De Grauwe P. (2012) - In search of symmetry in the eurozone, CEPS Policy Brief, 268, may
Deo S., Donovan P. e Hatheway L. (2011) - Euro break up, UBS investment Research, 6th september
Dornbusch R. (1996) - Euro fantasies, Foreign Affairs, 75. 5
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Feltri S. (2012) - Alla Germania nell’Euro servivamo proprio perché deboli. Parola di Visco, Il Fatto Quotidiano, 13
maggio
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23 November 2015
7
Frankel J.A. (1999) - No single currency regime is right for all countries or at all times, Essays in International
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and monetary union, Addison Wesley/Longman ed., New York
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Leijonhufvud A. (2008) - Central banking doctrine in light of the crisis, www.voxeu.org
Maddison A. (2001) - The world economy. A millennium perspective, OCSE, Paris
Manasse P. e Roubini N. (2005) - Rules of thumb for the debt sovereign crises, IMF wp 5.42, march
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Bertelsmann Stiftung, Policy Brief, 1/2013
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IES working paper
23 November 2015
8
IES working paper 23 November 2015
THE DEBATE ON EURO: INTERNATIONAL AND ITALIAN MATTERS
Quirino Biscaro
§ # +
ABSTRACT
In the first phase of the Monetary Union the discussion focused on advantages and disadvantages related to the
Eurozone. The Euro was founded with only three objectives, but absolutely relevant for the member countries: a
uniform growth among States, a strong defense by international economic and financial shocks, the control of the
inflation rate. After 15 years, only the inflation goal was fulfilled; but the Eurozone went even further: now the
problem is deflation, that is damaging as much as, if not more, of a high inflation. The growth of the member
countries is still asymmetric. In the spring and summer of 2011, some bearish operations on government bonds
have put in a corner Italy, Spain, Greece and Portugal. In the winter 2011-2012 Italy was "urged" by the ECB
toward a defined list of actions (to reduce its public debt and to realize some economic and institutional reforms),
because Euro was suffering a great danger. The concerns of the strong Eurozone countries were self-evident,
because a default of Italy would probably have resulted in the end of the Euro (one of the top 10 world's GDP, the
second EU manufacturing, a founding country of EU and Eurozone). This implies that Euro substantially fails the
remaining objective, perhaps the most important one: to defend the member countries from economic and
financial shocks. In fact, it was the Euro that would have to defend the member countries, and not vice versa. As a
consequence, the current debate moves on the convenience to leave the Euro. It must be outlined that in the
financial world there are conflicting opinions, whereas in the scientific world there seems to be a strong
orientation against the Monetary Union, at least in the format in which it is currently conceived.
§ International Trade Academic Center of Advisory
# School of Economics, Languages and Entrepreneurship (Univ. of Venice)
+ Fabbri Foundation
Keywords: Euro, Euro break-up, Monetary Union, ECB, UBS, Bank of America, Merryl Linch
JEL classification: E42, E44, E52, E58
IES working paper
23 November 2015
1
1. THE DEBATE BEFORE THE CURRENT CRISIS
"..... no more borders, no more customs, no more taxes, free trade ..... a continental currency .....
founded on Europe as a whole, with the free activity of two hundred million people as engine."
Victor Hugo, at a banquet in February 1855
At the end of the '90 the common people, the firms and the public authorities were asking themselves several
questions about Euro. The Monetary Union seemed ambivalent as a cure-all for the economy of the member
countries, as well as a bitter medicine that some strong-economy countries have wanted to give to the weakeconomies countries. The opinions were rather divided; they emerged two distinct parties: a base scenario (Eurooptimistic), founded on a strong Euro, and a opposite alternative scenario (Euro-skeptic), based on a weak Euro.
1.1 The base scenario: a strong Euro
The cornerstones of this scenario could be summarized as follows:
‐
‐
‐
‐
‐
a higher degree of cooperation between countries;
a higher resistance to speculation;
a cut (and a stabilization) of the financial costs, with savings in transaction costs;
a more precise planning of the business activity, due to a lower exchange rate fluctuation;
a competitive effect that sooner or later has a positive impact on employment and on the overall economic
growth.
Consequently the Euro-optimistic has foreshadowed that:
‐
‐
‐
‐
‐
in Euro countries starts a policy of fiscal consolidation;
the ECB earns prestige with a moderately restrictive monetary policy;
inflation remains permanently near (not over) 2%;
a institutional conflict between bankers and policy-makers has no reason to exist;
Euro becomes an international reserve currency.
1.2 The alternative scenario: a weak Euro
The supporters of the opposite scenario believed that:
‐ Europe already has a strong currency: the Deutsche Mark;
‐ Maastricht Treaty is founded on a one-way monetary vision of the economy: employment and welfare in
fact they depend on the currency, the only independent variable;
‐ is in itself a sign of weakness the freedom to join or not to Euro;
‐ there is a risk of a two-speed Europe, which in turn implies no Europe;
‐ there is a gray area between the skills of bankers and those of the policy makers;
‐ the ECB has a limited power compared to that typical of a central bank;
‐ in presence of an asymmetric shock, a national central bank can not act alone; without fiscal transfers from
the european central budget the shock would cause a segmentation between countries;
‐ the EU is not an optimal currency area, thus is not suitable for an economic and monetary union.
IES working paper
23 November 2015
2
2. THE EVIDENCE ALONG 15 YEARS
"The Euro should not exist. More specifically, the Euro as it currently constituted, with its current
structure and current membership, should not exist. This Euro creates more economic costs than
benefits for at least some of its members."
Deo, Donovan and Hatheway (2011), pag. 2
The Maastricht Treaty is actually unbalanced on the monetary side of the economy. One of the 5 parameters
of the Treaty is a technical nonsense: it is the well known Debt / GDP ratio, that compares a stock (Debt) and a
flow (GDP), with a devastating threshold (60%). If the banking system adopt it, it would grant a loan of 100,000
euro to those who have a gross income amounting to 167,000 euro !
The feared conflict between the bankers and the policy-makers is a reality.
After 15 year, the expected positive effects for the economy (employment and GDP growth) have took place
only for some Eurozone members: the fears of asymmetric development are materializing.
The ECB does anything than expected institutionally, that is flatten inflation. In fact, from 2011 it implements
monetary actions clearly and exclusively expansive: with the Quantitative Easing it reduces the cost of borrowing
for the Government involved, and it introduces a lot of money into the economic system. On the other hand,
inflation is lowering alone, due to the collapse in aggregate demand. If the ECB doesn't acts as a purely central
bank, is virtually useless.
The origin of the problem is clear: the Eurozone is not, and never has been, an optimal currency area. This is
the necessary condition to any single currency, but it requires compliance with at least one of two specific
features:
‐ the economies of member countries are homogeneous: they move in the same direction, at the same
speed, in the same periods
‐ the economic and social systems are flexibles enough to allow the equalization of asymmetries by
"migration" of labour, wage adjustments, automatic fiscal stabilizers (from the latter comes the Fiscal
Compact)
But it's not just this, although sufficient to explain the difficulties of Euro. There are other relevant factors:
‐ the Monetary Union is literally just monetary, and the Eurozone needs some common social and legal
policies;
‐ the current crisis has outlined the need of North-South policy actions;
‐ the lack of truly common policies allows divergent national policies;
‐ the european policy makers have not realized the threats hidden under some false opportunities: as an
example, the real estate boom of Ireland and Spain which actually turned out to be a speculative bubble.
Perhaps it is not yet the time to declare the Euro failure. However it is certain that the single currency has
failed to defend some member countries from financial shocks: a few bearish operations of about twenty banks
were sufficient to put in a corner 4 Eurozone member states (Greece, Portugal, Spain and Italy).
The difficulties of Euro are self-evident. At the core of the current debate there aren't the advantages for a
country that wants to join the Eurozone, but the costs to bear for a country that instead wants get out of it.
Briefly, the options under valuation are as follows:
‐
‐
‐
‐
the exit from Euro of a weak country;
the exit from Euro of the more competitive country (Germany);
a double Euro: one for the strong countries and one for the others;
the Euro break-up.
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About these options a lot of people have something to say, but it is necessary to pay attention to financial and
scientific world. It is also useful the shifting of the debate from the global level to the national level, to be more
specific and to discuss the more troublesome hypothesis among those questioned: the exit of Italy.
3. THE DEBATE WITHIN THE FINANCIAL MARKETS
In this section, the discussion is focused on the possible exit from Euro of Italy. This is an event likely disruptive
for Euro: among the 4 mentioned countries (Italy, Greece, Portugal and Spain), in the Eurozone Italy is the one
having an economic and political level of first magnitude.
3.1 The UBS opinion
Deo, Donovan and Hathaway (2011) states that the exit costs from Euro are dramatic for a weak country, and
still very highs even for a strong country. This implies that the Euro should be maintained even if it is absolutely
necessary to reform it1.
Considering Italy a weak country, the UBS study would assigns the following exit costs:
‐ the default of the public debt if it remains denominated in Euro, due to the inability to recover the
necessary foreign currency;
‐ the default of the public debt also if it becomes denominated in Italian Lira, due to unsustainable increases
in interest rate;
‐ the collapse of the banking system, due to a bank run;
‐ the exit not only from Euro but also from EU;
‐ the exit from EU would be also followed by european protectionist measures that should offset the benefits
of the (obvious) devaluation of the Italian Lira;
‐ some civil unrest, the risk of civil war or dictatorial tendencies;
‐ a fall of the GDP of about 40%-50%.
This scenario is likely for Italy? Anyone can give to himself the answer. Before you do, however, recall that UBS
uses extremes hypotheses: the yardstick is the Argentina at the time of its default. In detail:
‐ a devaluation of the national currency of about 50%-60%;
‐ a loss of about 50% of foreign trade;
‐ the costs of recapitalization of the banking system "transferred" on the depositors.
However, it is quite clear that Italy cannot be compared to Argentina at the time of its default, as it has:
‐
‐
‐
‐
‐
one of the top 10 world's GDP;
the second EU manufacturing;
a trademark that no one else can claim (Made in Italy);
a banking system certainly not among the most advanced but more solid than the argentinian;
a real economy much more diversified; to the manufacturing potential, Italy adds two others positive
factors: the touristic and the historical-cultural ones, as factors of growth unimaginable for Argentina (and
nearly all other countries).
The UBS study is also filled with other critical factors:
‐ the devaluation of the exchange rate is abnormal, if compared to that adopted by others [as an example,
the 11% of Woo and Vamvakidis (2012), the 25% of the french economist J. Sapir, etc];
1
"If the Euro does not work (and it does not), then either the current structure needs to change, or the current membership
need to change." [Deo, Donovan e Hatheway (2011), pag. 2]
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‐ protectionist measures envisaged against the outgoing country are possible only in case of exit from EU,
and however should have a unusual size to be able to offset the hypothesized depreciation (50%-60%);
‐ even with such a reaction of EU, it seems overstated to consider that international italian trade "is likely to
be disrupted" [Deo, Donovan and Hatheway (2011), pag. 7]: with the hypothesized devaluation, the Made
in Italy would become much less expensive (a Ferrari 458 basic version now costs about $ 256,000; with
the hypothesized devaluation the equivalent price drops under $ 130,000: it is therefore clear that its
potential market should grows out of proportion].
3.2 The Bank of America & Merryll Lynch opinion
A study of this bank [Woo and Vamvakidis (2012)] argues that an exit from Euro would not induce
unsustainable costs, and develops a scenario of a planned exit. Considering the 11 largest economies in the
Eurozone, the study comes to the surprising conclusion that Italy (together with Ireland) is the country that would
have the greatest incentive to abandon the Euro, given the cost-benefit balance.
This outcome is derived from a 4 steps model. The first is to test the strength in planning the exit from Euro.
On this point the assessment is based on the Primary Balance and on the Current Account Balance, both as a
percentage of GDP. After Germany and Austria, Italy stands at the third place in the ranking (with Netherlands).
The second step concerns the impact on growth. Based on the hypothesized depreciation (11% of the real
exchange rate), the share of exports to GDP and the growth potential (output gap), the study estimates a growth
of 3%. Italy would be second in the ranking (Ireland would be the first).
The third step is the impact on the (real) cost of public debt, for which it is hypothesized a conversion into
national currency. According to an econometric regression between the Standard & Poors country rating, the
nominal cost of 10-year government bonds and the inflation rate, it is shows that Italy surprisingly should benefit
for a reduction in the real cost of public debt of about 20 basis points (- 0.2%). Italy is the fifth country of the
ranking.
Finally, the fourth step is to determine the impact on the overall balance of the country respect of the rest of
the world. Refering to the Net International Investment Position (NIIP), stated by the IMF on the Balance of
Payments, the NIIP to GDP ratio would increase by 15%. In this aspect Italy is the fourth country of the ranking.
The 4 steps imply an overall ranking that push Italy to the first place (tied with Ireland). Therefore it would be
the Eurozone country with the greater convenience for a (planned) exit from Euro.
This scenario is likely for Italy? As with the UBS study, anyone can get a feel. However it is certain that:
‐ the parameters underlying the estimates are more appropriate to the size and nature of the Italian
economy;
‐ the results are derived from the application of a specific quantitative model.
4. THE SCIENTIFIC DEBATE
Many economists are measuring on problems related to Eurozone. Claims and counter claims, assumptions
and thesis abound. It is useful to summarize this complex debate briefly citing the thought of some great
economists. Some of them are facing the Eurozone problems from a general point of view, others specifically
mention the italian problems; the reported phrases were published on Il Sole 24 Ore on 17 December 2013:
1. Milton Friedman (from 31 July 1912 to 16 November 2006; Nobel Prize for Economics in 1976):
"The impetus for the Euro was motivated by politics, not economics. The purpose was to join Germany and France
so closely as to make impossible a European war, and to set the United States of Europe. I believe that the
adoption of Euro will have the opposite effect."
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2. James Mirrlees (Cambridge University, Nobel Prize for Economics in 1996):
"I would not to suggest policies to change the current situation ............ However, looking from the outside, I say
that you should not stay in Euro2, but get out of it now."
3. Amartya Sen (Harvard University, Nobel Prize for Economics in 1998):
"The euro was a horrible idea. ..... An error that put the European economy on the wrong track. A single currency is
not a good way to begin to unite Europe. Economic weaknesses lead animosity, rather than strengthen the
reasons for being together. They have a break-effect, rather than a binding one. The Europe doesn't needs the
tensions that have arisen."
4. Joseph Stiglitz (Columbia Business School, Nobel Prize for Economics in 2001):
"This crisis, this is an artificial disaster and essentially has four letters: Euro."
5. Paul Krugman (Princeton University, Nobel Prize for Economics in 2008):
"By adopting Euro, Italy has been reduced to the status of a Third World nation that has to borrow a
foreign currency, with all the damages that this implies."
6. Christopher Pissarides (London School of Economics, Nobel Prize for Economics in 2010):
"The current situation is not sustainable for much longer. It is necessary to abolish the Euro to create the
confidence that the member countries they had each other."
5. A SUMMARY
"I am sure the Euro will oblige us to introduce a new set of economic policy instruments. It is politically
impossible to propose that now. But some day there will be a crisis and new instruments will be created.”
Romano Prodi, EU Commission President, December 2001.
1. In the initial stage of the Monetary Union were discussed advantages and disadvantages for countries that
joined the Euro.
2. The objectives of the single currency were not many, but absolutely relevant for the future of the member
countries: a uniform growth among States, a strong defense by international economic and financial shocks,
the control of the inflation rate.
3. After 15 years, only one of these goals was fulfilled: the control of the inflationary pressures. Eurozone went
even further: now the problem is deflation, that is damaging as much as, if not more, of a high inflation.
4. The growth of the member countries is still asymmetric. This is perhaps the basic reason for the debt crisis of
the so-called PIGS (or PIGSI, as the majority of investors will also includes Italy).
5. The international financial markets, supported by a group of about 20 banks (including Deutsche Bank), in the
spring and summer of 2011 "have took the opportunity" with some bearish operations on government bonds
of PIGSI; a similar situation happened in 1993 against Italy and Great Britain (which were forced out the
European Monetary System)3.
6. In the winter 2011-2012, Italy was "urged" by the ECB toward a defined list of actions (reduction of its public
debt and realization of some economic and institutional reforms), because Euro was suffering a great danger.
The concerns of the strong Eurozone countries were self-evident, because a default of Italy would probably
have resulted in the end of the Euro (one of the top 10 world's GDP, the second EU manufacturing, a founding
country of EU and Eurozone).
2
He refers to Italy.
Banks obviously say that they have not speculated, but had released titles too risky. The facts are well known. As an
example, it is useful to refer to the italian case. Between 2011 and 2013, the changes in the spread between italian
government bonds and the german ones have induced massive sales. Almost always this occurred a few days before the
public auctions of italian bonds, and always the new bonds emissions were entirely placed; it must be outlined that this
happened at lower prices and higher returns than otherwise possible.
3
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7. This implies that Euro substantially fails the remaining relevant objective: to defend the member countries
from economic and financial shocks. In fact, it was the Euro that would have to defend the member countries,
and not vice versa.
8. As a consequence, the current debate moves on the convenience to leave the Euro. It must be outlined that in
the financial world there are conflicting opinions, whereas in the scientific world there seems to be a strong
orientation against the Monetary Union, at least in the format in which it is currently conceived.
"Europe was not suited to the single currency, as is the United States. Spain and Florida had the same
real estate bubble. The population of Florida has sought work in other states less affected by the crisis,
but the spanish did not have the same chance." (Paul Krugman, Il Sole 24 Ore, 17 December 2013).
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