Will it be a parallel currency or a parallel world for Italy?

by Shaun Richards

A feature of the credit crunch has been the way that certain ideas keep popping back up and never seem to quite disappear. So let us step back in time to September 2017.

Three of Italy’s four largest parties – the anti-establishment 5-Star Movement, the right-wing Northern League and Silvio Berlusconi’s Forza Italia – propose introducing a parallel currency after an election due early next year. ( Reuters)

I think Silvio was more trying to take the wind out of the sails of his opponents as if he really believed the suggestion below he could have tried it when he was in power.

Investors sold off Italian government bonds last month after Berlusconi said he was in favor of printing a “new lira” for domestic use, to pump money into the economy. Under his plan euros would still be used for all international transactions and by tourists.

Bur back then Reuters reported on something that has had if not a rave from the grave made something of a reappearance over the past fortnight.

The Northern League’s Borghi said Italy “has to be ready for the euro’s collapse,” which he sees as only a matter of time.

He is the architect of the party’s proposal – which Berlusconi has also hinted he would support – called “mini-BOTs”, named after Italy’s short-term Treasury bills.

Borghi says initially some 70 billion euros of these small denomination, interest-free bonds would be issued by the Treasury to firms and individuals owed money by the state as payment for services or as tax rebates.

That was his proposal back then and if we stay with Reuters we can jump forwards in time to last Saturday.

The so-called “mini-BOT” scheme, named after Italy’s Treasury bills, was drawn up by the far-right, eurosceptic League party and was unexpectedly endorsed by parliament last month in a non-binding vote.

Money,Money Money

As it happens Abba summed up the plan rather well back in the day.

Money, money, money
Always sunny
In a rich man’s world
All the things I could do
If I had a little money
It’s a rich man’s world

You see another name for a “small denomination, interest-free bond” is a bank note. One more bit is required in that the Treasury Bill would need to be perpetual or much longer than the usual term ( often 90 days but sometimes of a year or so). Then you are mostly there and the government can then effectively take advantage of what is called “seigniorage”. This is where the ability to print money leaves you with a rather large profit as your 1000 Lira bill costs if we use US Federal Reserve data say 1% to print so 99% is profit. What’s not to like about that?

So at this point of the 70 billion Euros equivalent printed we have 69 billion or so left to spend, or rather the Italian government has.

What could go wrong?

This starts at the central bank as seigniorage is usually their preserve. Looked at like that they are one of the most profitable institutions in the world. Of course politicians spotted that long ago and thus the cash flows to the national treasuries with a deduction for expenses as for example the cake trolley does not fill itself.

Thus it was no surprise to see ECB President Mario Draghi saying this at the last press conference.

Now about the mini-BOT, I think I’ve answered this question in the past when the possibility was raised; they are either money and then they are illegal, or they are debt and then that stock goes up. I’ll stop here.

So he is pointing out that there is supposed to be only one form of money in the Euro area, which is the Euro itself. What he did not say but was clearly referring to it as being legal tender as in you can always settle a debt using a Euro. Also he points out that if they are debt then they will be added to the calculation of the national debt, which is what the proposal is trying to dodge.

Oh and he did not stop there he could not resist something of a dig.

Certainly the reading that people have and markets have of this mini-BOT doesn’t seem to be very positive, but I’m only just stopping at what I said; it’s either money or debt. I don’t think there is a third possibility.

Later he did explain his position in an answer to a different question.

Well, it’s very difficult to foresee hypothetical events where you assume that the President of the ECB doesn’t behave in a way to preserve the euro.

So he and his successor ( as his term ends in October) will always look to protect the Euro and will therefore always be against any such scheme. After all it is in his job description.

The debt issue

The problem is that Italy has such a large public debt, which is also large relative to its economy. The 2.32 trillion Euros is 132.2% of annual economic output or GDP. Those who have followed my “Girlfriend in a Coma” articles will know that rather than being an over spender Italy has arrived at this situation mostly because its has failed to grow its economy. In the good times it rarely grows at more than 1% per annum but sadly in the bad times it falls as much as its peers, so ground is lost. That is highlighted by the current position where over the last year GDP has fallen by 0.1%.

Thus even what is not a relatively high deficit for the public finances leads to trouble. The 43.1 billion Euros borrowed in 2015 fell to 37.5 billion in 2018 but we find that it breaks the Euro area rules. Back to Mario Draghi.

The Commission has concluded that Italy must reduce its debt-to-GDP ratio and this opinion will go to the Council. By then the Italian Government will produce – and that’s what’s been asked – a medium-term plan for reducing debt-to-GDP ratios.

Bond Yields

There are two ironies here. Let me give you one which is there was an even better situation in late 2017 and early 2018 as Italy was being paid to issue some short-term debt. Some of that will be maturing soon and investors have escaped although in terms of risk/reward they have had a shocker. The latter irony is that the current “enemy” Mario Draghi headed an organisation which bought some 366 billion Euros of Italian government bonds known as BTPs. So he made debt issuance very cheap.

In spite of the current impasse and debate Italy can still borrow cheaply in historical terms with its benchmark ten-year yield being 2.37%. The problem is that in its current malaise that starts to look rather expensive.

Comment

This is one of those situations where the phrase stuck between a rock and a hard place applies virtually perfectly. Also there is an element of denial on both sides. This is because the real issue is the inability of Italy to grow its economy and whether that can be changed? If not then all the stimuli you can think of will not change things much. Indeed Italy could be worse off as whatever the presentation of it this new plan will leave it with more debt than before. Or a higher effective money supply which when we have seen it elsewhere in places like Ukraine has ended up in trouble.

On the other side of the coin the Euro establishment needs to face up to the fact that the promises of convergence which in this instance would mean towards the economy of Germany were false. In fact there has been divergence. We will never know how Italy would have performed if it had not joined the Euro but we do know that it has not been an answer to its lack of economic growth. The latest proposals via what are called “sauces” and some words from Olli Rehn are for more bond purchases and further interest-rate cuts. But if they worked we wouldn’t be here would we?

So we are definitely seeing parallel worlds, one of which may yet have a parallel currency

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