Diary of a Financier

The Full Monti

In Economics on Thu 17 Nov 2011 at 09:18

New Italian Prime Minister, Mario Monti, has been at the pulpit in an effort to instill confidence. The technocrat, who replaced Silvio Berlusconi last week, made the following comments:

To the question of what gets Europe out of this mess, Mario Monti, the new Italian PM said it simply when referring to Italy’s 120% debt to GDP ratio, exactly where it was 20 yrs ago, “We must convince investors that we can reduce it.”

Mr. Monti’s words were carefully sown, and they’ve spurred a recovery in global futures this morning (ES has swung from -0.8% to +0.12). Allow me to present a chart of the last 20 years’ struggle with Italy’s Debt/GDP:

Net Debt/GDP

Yes, that’s net Debt/GDP, not gross. So, when Mr. Monti reasons that ‘Italy emerged from 120% Debt/GDP in the 1990s, she’ll do it again today,’ I pitch my counteroffensive, which I’ve maintained since the start: the European Monetary Union will disband. The EU-17 should prefer to disband, but irrespective of preference, they will disband. What cured Italy’s 120% Debt/GDP in the 1990s? MSNBC has the answer:

In the early 1990s, Italy’s outsized budget deficits meant it faced the possibility of being left out of the euro — a deeply humiliating prospect. Deficits were slashed. The government confronted unions over cuts in pensions and won. Taxes went up. Government-owned companies were sold to reduce debt. Italy joined the euro as a charter member in 1999.

…and Italy averaged GDP growth at an insufficient 1.23% clip over that period, compared to the Eurozone average of 2.28%… not that the government owns enough companies today to repeat the modest feat.


Take a moment to compare the GDPs of Italy & the United Kingdom throughout the 1990s, with particular attention toward the catalyst of Black Wednesday:


Italy GDP

Notice anything? The UK’s growth surged after it withdrew from the ERM I. Currency independence aided the launch of a secular boom for the Brits–something which garnered accolades to rebrand September 16, 1992 as “Golden Wednesday.”

Italy’s growth, in contrast, sputtered. They devalued their Lira more than 7% on Black Wednesday, then promptly returned to the ERM. This second chapter in ERM revised the bandwidths for currency fluctuation from 6% to 10% (in the case of the Lira). With Italy’s wonkish growth as a testament, the rigidity of a currency peg–even a floating peg–is too unnatural to survive long-term:

ERM I artificially manipulated FX rates for too prolonged a period. You can’t fight nature for the long-term and expect to win. Hence, the Black Wednesday crash in 1992 manifest the gravitational force constantly drawing the Pound Sterling and Italian Lira down toward their fundamental equilibria. The force intensified the longer ERM exerted FX dislocations per its “bandwidth pledge.” The current European Monetary Union (EMU) and its single currency, the Euro, will suffer the same fate as the shattered, defunct ERM.

In 1993, this revised ERM-II was revised wider still to 15%, eventually ushering in the semi-integration of the current EMU in 1999. My point is that currency independence boasts substantial benefits for a sovereign. I don’t mean to come-off as a major Modern Monetary Theory (MMT) proponent here, but my message is something to that effect. (Citing history as its evidence, MMT in my opinion dismisses the critical role of “confidence” in supporting a fiat regime.)

I’m just piling-on Europe at this point.




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