How Italy Will Fail And Drag Down The European Project
Submitted by Eugen von Bohm-Bawerk via Bawerk.net,
Italy is big enough to matter (it is the eight largest economy on the planet), but so uneventful that most does not pay any attention to what is going on there. We contend that Italy will, during the next year or two, be on everyone’s radar screen as it has the potential to derail the European project for real.
Greece, Portugal and Ireland were mere test subjects for what will come. Spain would have been a challenge, but were narrowly avoided. Italy will drag the whole structure down if it continues on its current trajectory, and there is nothing to suggest it will change course.
The main problem for Italy is its stagnating level of nominal GDP, which we refer to as “Japanificaton” of the economy. While people usually think of deflation when they hear “Japan”, that is not an entirely correct observation. It is true that nominal GDP flat lined after the crisis in the 1990s which dragged down revenue. However, if it was truly a deflationary period, expenditures should fall also as prices paid for services rendered would drop concomitantly. This has not been the case and it is more correct to say Japan has been trapped in a revenue / NGDP deflation, hence the perceived need for Abenomics, or in plain English, the creation of a helluva lot of currency units to boost NGDP and revenue and thus reduce the need for bond issuance. As our first chart show, so far it has been modestly successful. Please note that Abenomics have nothing to do with creating real prosperity (no one can be that ignorant), but all about getting the spiraling debt problem under control by jacking up the inflation tax.
Italy is now more or less in the same situation with tax revenue struggling to keep up with current expenditures, id est government consumption. Investments, which can be lowered today without immediate consequences suffer and are now, nominally, at the same level they were in the early 1980s. When revenue flat lines, due to lack of investments, and current expenditures keep rising the shortfall is made up for by debt issuance. The gaping hole between future prospects (a function of bad decisions in the past) and flat lining revenues is fiendishly difficult to plug as it require large sacrifices today, without any payout for years to come.
Just as in Japan, Italy is trapped with stagnating nominal GDP versus ever growing debt levels used to pay for current expenditures enshrined into law and politically enforced by an ageing population with a feeling of entitlement. As our next chart shows, there is a sense of inevitability baked into the Italian cake. We all know a day of reckoning will come because the current trajectory is, put bluntly, unsustainable. Something will have to give as the Italian state, just as the Japanese one, uses household savings to fund state consumption while giving the populace the sense of investing their money for the future. In other words, Italian households put their money in the bank or in public pension funds, which is used to fund current retirees, but expected to provide a cash flow for their own retirement. The circularity here is obvious to anyone willing to look. There are NO savings, they are only visible on balance sheet statements, but are so far removed from what constitutes real productive investments as possible.
As productive investments are sucked dry by an ever expanding state and its incessant need to fund current expenditures there is very little the banks can do to spur investments and underpin growth. It is no coincidence that banks assets flat lines alongside nominal GDP. They are both closely interlinked and as banks find no customers willing or able to borrow money and invest, they naturally scale back and so the money supply growth grinds to a halt, either through a falling money multiplier and/or through falling velocity. Either way, nominal GDP stops expanding, while the insatiable need for public spending keeps public debt rising relentlessly.
Note that every action taken by central banks until just recently has been an act, be it ZIRP, forward guidance or QE, to manipulate demand for credit, which obviously failed miserably due to the balance sheet constraints prevalent in both the private as well as public sector. In order to alleviate this, negative interest rates is designed to force supply onto a hapless public by making it too expensive for banks to maintain excess reserves at the central bank. Needless to say, this is a doomed policy to begin with. If there are no credit worthy borrowers willing to borrow money, then forcing banks to push credit to a non-worthy or non-willing public is sheer lunacy; but the desperate need to create NGDP growth runs so deep that it trumps common sense. In this sense it is interesting to note that the sectors with positive loan growth, after the ECB has gone all in, is exactly the unproductive sectors that should deleverage and free up resources to the productive sector. Alas, this is not what is happening.
It should thus come as no surprise that Italian investments are falling behind it’s, admittedly lackluster, peers. According to Eurostat Italian gross investment are lower today than they were in the mid-1990s. Knowing that a capital base depreciate around 20 per cent annually, we would not be surprised to learn that the Italian capital stock is in terminal decline as the current structure of production and Italian consumption pattern cannot be sustained without actually consuming the capital stock.
One piece of evidence substantiating our claim is the fact that labour productivity is falling in Italy. If capital per worker is falling, as it would in a situation where, through depreciation, capital is consumed, one should expect lower output per worker. This is exactly what has been going on for the last 15 years. The process accelerated as investment peaked and fell after the GFC, just as we would expect it to do.
Since policymakers identify the problem as lack of credit, completely missing the point that credit cannot be given to a person, but is something that person already have, policies are naturally focused on increasing credit and by extension money supply and consequently inflation/NGDP. Focus has therefore shifted from what could by now be called conventional monetary policy tools such as QE and liquidity injections through TLTROs to one of negative interest rates and bad debts.
Italian banks are officially swamped with €200bn worth of non-performing loans, while unofficial estimates put it as high as €350bn. At €200bn, it is growing at double digits per year and constitutes more than 12 per cent of NGDP. Non-performing loans in the non-financial corporate part of the portfolio is close to 18 per cent.
While this obviously has to be dealt with somehow, the focus now is for the bad debts to be cleansed from banks balance sheets so they can start to lend money again, which is just an euphemism for creating credit, inflation and “growth”.
The Italian government presented a plan in January that underwhelmed markets as they were essentially constrained by EU regulation on state aid to come up with something that would benefit Italian banks (on behalf of the Italian tax payer we presume). In addition, a clear cut bail-out now comes with new strings attached, essentially forcing bail-in of debt holders and unsecured depositors before any state aid can be handed directly to banks.
So how will the problem eventually be dealt with? We got a clear hint during Draghi’s testimony to the European Parliament when he told his audience that NPLs can be added to asset backed securities which would then be eligible for the ongoing ECB QE program. This would be a win-win situation for the money masters as the ongoing QE program, unlike earlier ECB interventions, actually remove credit risk from banks balance sheets. In addition more ABSs would alleviate the shortage of securities the ECB is currently struggling with. Frankfurt is thus frenetically looking for additional assets to buy in order to avoid the BoJ trap. As of today, less than 5 per cent of Italian banking assets are securitized, while simultaneously ECB’s Asset-Backed Security Program is the least successful with only €18bn purchased so far, compared to €155bn in the third Covered Bond program and almost €600bn in the Public-Sector purchase program.
The underlying solvency issue is obviously not solved by this trickery as credit risk is just moved from the private banking industry to the public sector. And this tells us what is probably glaringly obvious to all, including the men and women in charge, that the only thing that can truly lead to positive change is a real crisis. Only then can we honestly deal with reality through debt write-downs, re-alignment of consumption with production and end the sense of entitlement. The electorate, politicians and most of the bureaucrats running Italy and Europe will always opt for the extend-and-pretend option as long as it is available to them; this is especially true when they have dug themselves so deep into troubles that there are no pleasant way out. In other words, change, real change, will not come until it is absolutely necessary, forced upon them by the ultimate monetary end-game.
While it is true that monetizing bad assets may initially be perceived as the way out for Italy, as banks can once again expand their balance sheet and in the process kick start nominal GDP and get the debt to GDP ratio under control, the fact is more ominous – Italy is a train crash in slow motion. Italian consumption outstrips production, and it has done so for years. The capital base is being eroded, labour productivity is falling (and we haven’t even touched upon its dire demographic situation) and living standards stagnating. The only thing that keeps this thing running is its ability to roll-over and issue debt.
They got dangerously close to being shut out of that window in 2012, and since then nothing has changed. Italy still needs to roll over bonds worth 25 per cent of GDP per year and the slightest hiccup will bankrupt them in no-time. The key is obviously a “healthy” banking system willing and able to keep buying newly issued bonds as old retire.
With debt to GDP ratios over 100 per cent of GDP the interest rate sensitivity grows exponentially. As average interest paid on outstanding debt rose a meagre 40 basis points during the Euro Crisis of 2012, interest expenses as share of GDP rose 80 basis points. And back then, the ECB managed to rid the Italian treasury from roll-over risk quickly enough to save them. Next time, when the Central Bank narrative has changed from one of omnipotence to one of failure they may not be so lucky. If we assume Italian interest rates were at it is 2000 – 05 average of 4.8 per cent, they would today pay 6.5 per cent of their GDP in interest only.
When Italy finally succumbs to reality, this year or next, the European project as they call it will face insurmountable hurdles and collapse on itself.
In our view, seeing the parasitical edifice in Brussels disappear can only lead to good things. Maybe the Brits will save us the agony and end it June 23rd. One can only hope.
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Appendix – Bonus Charts
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In the latest Wikileaks release, Berlusconi is quoted as saying Italian banks were about to "pop like a cork". [Spumante, I presume].
Berlusconis is misquote, actual quote is about underage hooker.
Really? From which orifice?
No problems.
Germany will be there to pick up the tab.
To paraphrase Mr Takagi:
"The Third Reich didn't work out so we got you (by the balls) with debt."
However - the Germany export machine and the Baltic Dry are telling two different stories - wait till the lag time catches up with the order books of the former (VW aside for obvious reasons).
How much of Germany's GDP is China-related? German economy go down - bye bye EU project (the nice cuddly version).
I read this article just like I did when I read that article about that near miss asteroid.
What the fuck am I going to do about it except tuck my head between legs and kiss my ass goodbye?
There are no answers on this site. Just more Russian psy-ops.
Heil Hydra!!
So Down Arrow guy must have an answer on what to do with all this information. You have actionable real world advice that actual human beings can use?
Share it.
I dare you.
Heil Hydra!!
Hey, I didn't down arrow, but have a comment about the asteroid.
Really funny that the minimum near miss is something like 20000 km, while the far miss limit is supposed to be 9 million km. NASA says no chance it will hit earth, even though they do not even know which day will be closest approach.
Humorous part is that the near miss distance is a fraction of 1% of the uncertainty range. Yet, they claim a hit is impossible. Can't narrow it down less than 9 million km, but SURE their near miss is correct to this tiny percent.
It is not something to worry about, but simply amazing that even scientists can make such ridiculous claims. Trying to compete with economists, I suppose
“Here's a phrase that apparently the airlines simply made up: near miss. They say that if 2 planes almost collide, it's a near miss. Bullshit, my friend. It's a near hit! A collision is a near miss.
[WHAM! CRUNCH!]
"Look, they nearly missed!"
"Yes, but not quite.”
– George Carlin
Better yet, think about this. They identified it 21 days before its closest approach, but didn't bother to notifiy the public until the last minute. The public always hears about a near flyby in the past tense. What does that tell you about what's going to happen when they discover the one that's going to hit?
Misery loves company OR someone to hug when the asteroid hits.
No need to insult Boris. He's right up there above you, monitoring.
Bwahahaha, 1-2 years? This fucking world isn't going to look anything like it does today in 2 fucking years! It's careening off the guard rails right NOW. Italy will be wherever it's going in a lot less than 2 years.
I'm making over $7k a month working part time. I kept hearing other people tell me how much money they can make online so I decided to look into it. Well, it was all true and has totally changed my life. This is what I do... www.wallstreet34.com
Data is poor, no graphic.
Or Italian chicks in bikinis.
...violence
Tsk, Italy is one of my favorite places. I'd advise everybody not to overlook France because they really aren't any better off........
You can tell how bad the French economy must be, by the number of Frenchies working in the UK. If you are French, and your best option is to live in Britain? The end is nigh!
Anybody want to buy a ticket for the EU Titanic?
250 billion EUR paid out by Banca D'Italia without 250 billion coming back. That looks like a pretty big run on a bank to me. What's their liquidity position for that? Load the nostro up with 1bn a day and watch it all disappear?
You said this about greece ............ liar liar
No need to explain. Just look at the old EU and which currencies had several zero's behind the real numbers.
Italy, Spain, Portugal let us not forget France also.
Banks do not insure growth. New ideas (technology) is the engine of growth. We are temporarily short of ideas. The Kondratieff Cycle.
We need revolutionary ideas that lead to explosive growth, not just improvements. The problem is that these ideas are mostly taken over by the squid and when they engineer a downturn, they release nothing new nor inspiring.
An exception is Tesla Motors.
Tesla Motors is about as inspiring as it gets, and is about to introduce a mass production electric car for 25K.
Examples of how innovation and explosive growth industries are fought tooth and nail:
Surprisingly, New Jersey is not the first to block Tesla vehicle sales. Colorado, Texas, Arizona, and Virginia have all prohibited Tesla from selling cars in their states.
http://preservefreedom.org/new-jersey-bans-the-sale-of-tesla-electric-cars/
SolarCity was denied solar net-metering in Nevada.
The fight was over solar net-metering in Nevada, a state that has the fifth largest installed solar capacity in the country. Nevada is home to Tesla’s ‘Gigafactory,’ which will produce batteries for electric vehicles. In addition to CEO of Tesla, Elon Musk is also the chairman of SolarCity, and net-metering – the policy that allows homeowners with solar panels to be paid for the power they produce – is central to solar economics.
http://oilprice.com/Alternative-Energy/Solar-Energy/Warren-Buffett-Beats...
Private, multi-ton transport isn't going to do anything for "growth." It is just pissing away your energy whether gasoline or 6,840 lithium batteries per car.
Both private and commercial auto industries always have been important for growth, jobs, services, and supply chains, as well as maintenance and spare parts and the oil industry.
Commercial electric vehicles and trains are already used in many parts of the world. Not so much in the US.
What commercial electric vehicles need is the efficiency and scale of Tesla Motors, and the Lithium extraction scaled up (already being adjusted) and a battery factory capable of delivering (also being finished in Nevada).
The US finally has a special vehicle that out classes any other and here you go pissing into the winds of positive change.
Once scaled up, Tesla Motors (an American company) will eat at the foreign competition and bring real growth to the US, by displacing foreign vehicle sales.
Also you can charge for free at the Tesla charging stations so what you say makes no sense at all.
Battery replacement costs in 8 years (battery warranty) will be dramatically lower, thanks to the decreasing costs of lithium technology and factor in next to nothing in engine maintenance costs during 8 years because it is electric and way simpler than internal combustion engines, probably covers normal vehicle depreciation costs. Add to that 8 years of gasoline costs that you saved. Gasoline is cheap now in the US, but it will not last forever.
Go ahead and delude yourself that electric is not here to stay.
Perhaps Magic will share some over due ideas?
These stories about feckless Europeans, usually in the Catholic South, always come out hot on the heels of a sterling crisis. You'll never hear about how the UK is the most vulnerable country in the EU to financial meltdown because as soon as a sterling crisis unfolds the media make sure people's attention is shifted elsewhere. They had a good laugh among themselves over the feckless PIIGS - Catholic Portugal, Catholic Ireland, Catholic Italy, Catholic Spain and Orthodox Greece. WASP America does the same with Catholic Mexico - the feckless Mexicans are to blame for society's ills in WASP America, especially if a financial disaster is looming.
It's like clockwork: financial crisis in the UK = media stories the next day about useless, feckless peasants in Catholic Europe. Forget the indebtedness of the UK and the USA, which far exceeds anything in Europe; the only thing you need to know is that little old ladies in Catholic Italy are going to have their pensions wiped out. Oh, and just ignore the fact it's usually British and American hedge funds who are behind this financial trickery and theft in Europe in the first place.
But this old ruse is wearing thin now. My guess is the next major sterling crisis won't be quite so easily masked by cooking up crises elsewhere. And good riddance. As far as the City of London is concerned the end of their death-grip on the human race can't come soon enough for me.
Fun little known fact about The City, it is basically a city state within the UK and even Parliament have no authority over it. There is however a bloke called The City Remembrancer who hangs around near the speaker of the house of commons to ensure the City gets it's way.
The City of London is the only part of Britain over which parliament has no authority. In one respect at least the Corporation acts as the superior body: it imposes on the House of Commons a figure called the remembrancer: an official lobbyist who sits behind the Speaker’s chair and ensures that, whatever our elected representatives might think, the City’s rights and privileges are protected
http://www.theguardian.com/commentisfree/2011/oct/31/corporation-london-...
A lot of power emanates from The City.
https://en.wikipedia.org/wiki/City_of_London
Yes, perhaps the rest of Britan should build a wall around London and let the fuckers inside eat each other..
Definitely would be an improvement. a few cities in the U.S. would also benefit from such treatment.
Washington, New York, Chiraq, Texas,
well done Det. Stern. good stuff. Clear whose driving the stake thru Brexit dragon isnt it.
It's a form of porn.
When your own jurisdiction is in serious trouble
you merely point out "how much more pain"
the other guy will be in.
Problem is, these "southern Catholics" all enjoy
the benefit of better weather and better agricultural
prospects... read: the financial world will go to (!)...
but they merely go out in the garden and harvest
their supper... no "financing" required.
I am a feckless Catholic and didn't consider it a positive attribute until now. I will remain feckless untill they give me back the feck, at whick point I will consider paying for it.
I love this site, even with the comments about spumante corks in various orifices.
We are told nothing anymore. Bank runs coming all over the world soon.
Cannabinoid medicine - fully implimented - could destroy 75% of the medical industrial complex. It cures cancer. A LOT of writeoffs will be required idf it is even only 20%.
The incumbents wouldn't like that. Thus continued Prohibition.
Next time, try reading the full study. It was the massive doses of Cherry Garcia that apparently did the trick, not the Cannabinoids.
I have reservations about statements that countries have been healed or problems have been narrowly avoided. Spain and Portugal are as problematic as they ever were and Italy is the same. That holds also true for Ireland and the UK, which as one comment highlights correctly seems to be also resting at the brink. Add Greece, Croatia, Bulgaria and Romania and you have a multimorbid patient that is pretending to be well. The EU is a failure at least in its present format.
I have reservations about statements that countries have been healed or problems have been narrowly avoided. Spain and Portugal are as problematic as they ever were and Italy is the same. That holds also true for Ireland and the UK, which as one comment highlights correctly seems to be also resting at the brink. Add Greece, Croatia, Bulgaria and Romania and you have a multimorbid patient that is pretending to be well. The EU is a failure at least in its present format.
Italy has already failed - we are just waiting for the world to recognize it!
So the UK is better leaving in June before EU Titanic hits the iceberg.
Ditto for Greece, Portugal, Spain and France.
The true state of Europe was exposed today in the words of an Austrian government official with involvment in migrant crisis in Europe. Not speaking directly to banks or state finances, his message revealed the EU's underlying crisis,
" In Europe, we no longer have the means to cope with continued large migration. We do not have the space anylonger. We do not have any jobs for these people. Government hasn't the money to build housing for such large numbers. Budgets of states can not be rasied as taxes threaten to choke any hopes of economic recovery. Too many economic shortfalls and little true growth in the real economy will allow Europe to be the provider it once was to migrants, they must stay where they are and accept the help we can send to them in their states and camps. Europe is not the bottomless source of wealth migrants have been told to expect."
Well, you better get to work on that wall Jack! "Laws" that cannot be enforced are about as effective and borders that cannot be enforced!
Just think how much debt these new sheep would add to the system
The EU is designed to genocide europeans:
http://www.redicecreations.com/radio/2016/02/RIR-160222.php
Bullshit. "Defaults" are illegal, they simply do not happen anymore, just ask Greece and Cyprus!!!
The writer does not pay attention too. His grammar fails right in the first sentence.
that most does not pay any attention to what is going on there
it is the eight largest economy on the planet
All eight of them? This is a bigger crisis then we thought!