What Happens if Italy Dumps EMU and the Euro? Devaluation, Default and Lira-lization of Euro Debts!
Today’s comments by Italian PM Silvio Berlusconi that the Euro has been a “disaster” and a “ripoff” are certainly dangerous and reckless: Berlusconi is playing with politics and fire by using the euro card as a way to attack Prodi and the center-left coalition in anticipation of political elections where the center-left may regain power. Until now only the hot heads in the Northern League – like Minister Maroni – were trashing EMU and suggesting that Italy should dump the euro and return to the Lira. But now Berlusconi himself is making such incendiary remarks. Of course, as the wiser economics minister Siniscalco has suggested, returning to the lira would sharply increase the public debt servicing costs as Italian interest rates may sharply increase; after all Italy benefited a lot from the convergence of short term and long term interest rates to European level in the transition to EMU.
But, in spite of these hot-headed and dangerous comments of Berlusconi, one needs to ask the hard economic questions: what will happen to the Italian economy if Italy stays in EMU? Would Italy be better off by returning to the lira? What would be the economic and financial consequences of returning to the lira? As economists, we need to ask and answer these difficult questions as the case for Italy staying in EMU is not all clear cut.
Those who argue that EMU and the euro have been a disaster compare Italy with Argentina. The argument is as follows: Italy entered EMU at an overvalued real exchange rate. Then Euro sharply appreciated relative to the US dollar in 2002-2004 (in spite of its modest weakening in 2005) and Italian firms further lost competitiveness. Also, Italy’s traded sector is in direct competition with China and Asia: some estimates suggest that about 20% of Italian GDP is under direct threat from China and Asia as Italy specializes in more labor-intensive lower value-added exports such as textiles, apparel, shoes, light manufacturing, etc. How can Italy compete with Chinese and Asian costs, the critics of EMU ask?
And indeed, the recent economic growth performance of Italy has been dismal with growth stagnation and now a recession. Like Argentina in the late 1990s, the external competitivenss shocks could lead to a protracted and deepening recession in Italy and to a price deflation spiral that would increase real interest rates in spite of low nominal interest rates. Also, recession and high real rates will worsen the public debt dynamics by increasing further fiscal deficits and increasing even more an already very high level of public debt. Eventually, like Argentina, Italy may need a nominal and real devaluation to restore competitiveness and growth. In the case of Argentina this meant dumping the currency board and the dollar peg. In the case of Italy, that would mean to dump the euro and go back to the lira. Like Argentina, Italy may need a very large real depreciation of the new lira – relative to the Euro – to regain competitiveness.
Of course, the ideal way to deal with this competitiveness issue would be for Italy to accelerate its structural economic reforms. Italy has already done that to some extent: the labor market today is much more flexible than a decade ago as various forms of part time and unofficial and underground employment are now the norm in Italy. Still, real wages may need to fall much more in order to achieve a real depreciation and, if real wages are downward rigid, Italy may need a painful period of deflation with falling nominal wages and prices to achieve the necessary real depreciation. And like in Argentina, such deflationary process may lead to lower growth and higher real interest rates and thus worsen the debt dynamics.
Thus, Italy may need a real depreciation via a nominal depreciation to achieve the needed recovery in competitiveness; this would then require dumping the euro and going back to the lira. This competitiveness argument has some merit even if the main reason why the Italian economy has stagnated has been that the Berlusconi government has done little or nothing to reform the Italian economy in the last few years. Berlusconi is a sleazy crook who made his first financial fortunes by exploiting his political connections to build a media empire and monopoly; so much for free-market neoliberalism! And he has been enmeshed in endless scandals and criminal investigations and trials. So, for him to bash today Prodi and the center left and the euro for the problems of Italy is a self-serving apology for the utter failures of his own policies.
But, in spite of these self-serving and dangerous comments, Italy does face a real competitiveness problem, in the same way that Argentina has a competitiveness problem given its external shocks. So, if Italy could achieve a surgical real depreciation of its currency via a move back to the lira, the competitiveness problem could be addressed. Of course, this real devaluation of the new lira would imply a sharp reduction of Italian real wages in Euro terms; so, Italy could regain competitiveness in world markets by effectively reducing its real wages.
However, the main problem with moving back to the lira is not the issue of the effect of a real depreciation on competitiveness as that effect, coeteris paribus, would be a positive for Italian growth. The real problem for Italy would be, once it moved back to the lira, to decide what to do with its euro denominated debts, the liabilities in euros of its government, of its private sector and of its households. And dealing with the balance sheet effects of a move back to the lira on the euro debts of Italy would be a much bigger financial mess than anything else. This was also the essential problem that Argentina faced and that led to default and pesification of its dollar and foreign currency liabilities (for the Argentina case and the dilemma it faced regarding dollarization, float, default and pesification see my two 2001 papers here and here).
Let us consider this problem in more detail. Any time a country that has foreign currency liabilities decides to depreciate its currency, the real value in local currency of its foreign currency debts goes up. This is what is referred to as the balance sheet effect of a real depreciation. In the case of Italy, say a 30% depreciation of the new lira relative to the Euro would imply that the real value of all Euro denominated debts of the government, corporates and households would go up by 30%. Some of these balance sheet effects would be a redistribution of wealth to non residents: the liabilities of the Italian government, corporates and households owed to foreigners would increase. But some of it is redistribution of wealth within Italy: for example, holders of euro assets such as Italian holders of the public debt in euros would be richer while the real burden of such euro debt for the italian government, already burdened by a high debt to GDP ratio, would go up by 30%. So, already a semi-insolvent Italian government would likely become fully insolvent if its real debt to GDP ratio would go up by 30% overnite.
How to solve these balance sheet effects of a real devaluation? As the experience of Argentina shows, the solutions are painful regardless of. Italy could decide to honor all of its euro liabilities, whether they are owed by the government, the private financial and corporate sector or its households. And, indeed, Northern League supporters of the return to the lira have argued that Italy would want to maintain its euro debts after dumping the euro. But like in the case of Argentina, many private sector agents may n
ot be able to afford an increase in their real euro debts of the size of the real depreciation of the lira. So, households may default on their euro mortgages, firms may default on their euro debts and even the government may have to restructure and reduce its euro public debt. So, outright default with all its ugly consequences is one solution to problem of the balance sheet effects of a real devaluation.
Alternatively, like in the case of Argentina, Italy could decide to ”de-dollarize” and “pesify” or, in this case it is more correct to say, Italy would have to “de-euroize” and “lira-lize” its euro debts. So, like Argentina that pesified its domestic and foreign dollar liabilities, Italy would have to convert into the new liras its euros debts (see also the comments of Bloomberg columnist Gilbert along the same lines).
Who will bear the burden of this lira-lization? In the case of Argentina, the country was a net foreign debtor and thus, pesification implied that non-residents holders of Argentine dollar liabilities lost. But even in the case of Argentina, some of the dollar assets and liabilities were domestic and thus pesification implied redistribution of wealth from dollar creditors whose real assets fell in value after pesification to dollar debtors whose dollar debts were pesified and thus reduced as their were converted from dollars into pesos at an exchange rate value below the new market value after the move to the float. In the case of Italy, specific agents and firms in the economy may be net borrowers relative to the rest of the world but the country, as a whole, does not have a large amount of foreign debt. So, the losses from lira-lization of euro debts would be mostly redistribution of wealth and capital levies among different domestic agents, firms and the government. For example, lira-lization of the public debt would be a capital levy, i.e. a wealth tax, on all holders of Italian public debt.
Still, the losses to non-residents may still be severe as in the integrated European financial markets many non-residents hold Italian public debt in euros and many Italian financial institutions and banks have euro liabilities owed to non residents. Thus, lira-lization of Italian euro debts could have massive financial effects on other European financial institutions that hold such Italian euro liabilities. Severe contagion from an Italian default and lira-lization could occur and lead to painful systemic effects on European financial markets.
Of course, other problematic consequences would ensue: the external value of the euro would sharply fall as the probability that other EMU countries – Germany, Greece, etc. – would follow the Italian example would increase (see an interesting study by HSBC on the risks faced by EMU). And, certainly, the interest rate on the new italian lira debts would sharply increase as both devaluation and default risk would be sharply higher for a while. Of course, the Argentina example suggests that after a devaluation, default and de-dollarization have been associated with a severe economic and financial crisis, the economy would sharply recover and interest rates may fall as long as inflation is kept under control via some inflation targeting regime.
But Berlusconi and Italy should not delude themselves that going back to the lira would be painless and easy: before growth recovers, you would have devaluation, default, lira-lization of euro debts, bank runs and a systemic banking crisis, a systemic corporate crisis and a financial meltdown with severe international consequences.
Is it worth for Italy to pay such costs to achieve a real depreciation and resume growth? The real costs of financial crises are massive and Italy should try to avoid such an crisis scenario but, unless Italy dumps the Berlusconi gang, changes government soon and starts a process of meaningful economic reforms to restore growth and competitiveness, Italy may end up, like Argentina with no choice: it may have to go back to the lira, devalue, default and lira-lize its euro debts. In the case of Argentina, the move to a float, default and pesification became unvoidable given the size of the external shocks that hit its economy, the fact that it had a large and growing current account deficit, it had experienced a sharp real appreciation that needed to be undone and it had a public debt burden that was clearly unsustainable. Italy’s fundamentals are not as bad as the current account is in a surplus, the lira is not massively overvalued, the external shocks are more modest and given, its primary surplus, the debt levels are high but not spiraling out of control.
So, hopefully Italy will avoid an ugly financial crisis, but it will take better economic policies than those of Berlusconi to prevent this potential and disastrous mess. And certainly the reckless comments by Berlusconi today are stupid: they do not solve the Italian economy’s problems and they risk to lead to a self-fullfilling increase in Italian euro debt interest rates that may trigger a deeper economic downturn that could then trigger an otherwise avoidable currency and debt crisis. As correctly argued by Morgan Stanley’s Chaney, the Euro is a convenient scapegoat but, if Berlusconi and Italy play with fire Rome will burn and its modern Nero Emperor – Mr. Berlusconi himself – may end up destroying Italy while immolating himself on the top of this funerary pire. If Mr. Berlusconi has suicidal tendencies he can get rid of himself and provide such a generous and long-needed gift to his country-men; unless he is a modern Nero madman, he should not take the entire country with him and burn Rome again. Italy deserves better.
23 Responses to “What Happens if Italy Dumps EMU and the Euro? Devaluation, Default and Lira-lization of Euro Debts!”
Heinrich Ulmer • July 28th, 2005 at 7:38 pm
I think Berlusconi is the “disaster” for Italy – not the Euro. A buffoon president who calls the currency and thereby the savings of his entire country a “disaster” is truly a farcical president ! Berlusconi is constantly taking the wrong decisions – he dragged Italy into the Iraq quagmire and now he has no clue on how to bring them back. Now he calls his own currency a “disaster”… Romano Prodi would make an ideal president for Italy; he is a true European who would bring Italy back as a serious influential member of the EU. Berlusconi is too corrupt and too much of a clown to be taken seriously – unfortunately as he owns a majority of Italy’s media it is very difficult for any candidate to defeat him.
otto • July 29th, 2005 at 1:12 pm
This post is intemperate in its criticism of Berlusconi, and let’s EMU too much off the hook. 1. Berlusconi may be a sleazy crook in your words, but he did not create Italy’s economic difficulties, either as to debt or the labour market. Their roots lie in the Christian Democrat era pre-1992. It is true that Berlusconi has not fixed these problems. Neither has anyone else at the helm since 1992. They are not readily fixable, as Prodi will find if he is re-elected. 2. The Euro must take more of the blame. It was seen by too many as a panacea for all Europe’s economic woes and a way of avoiding other reforms. Not enought attention was given to what would in fact happen if a country was facing real economic difficulties, and would usually have been tempted to a devaluation. It was considered impolite in EU circles to mention this scenario. Now the Euro has raised the costs of devaluation considerably, but the temptation remains. And, secondly, in the spirit of European unity, Germany would not or could not bring itself to veto Italy’s entry into the Euro until it met the convergence criteria without gimmicks. So this possible disaster can be directly attributed in part to that blend of euphemism and obstacles to straight-talking which specially affects EU policy-making.
Anonymous • July 30th, 2005 at 1:32 am
This idea that all Italian problems were created before 1992, and that current politicians have (almost) no responsibility is “ad hoc”, and contradicted by facts. (1) The Italian public debt fell annually by 2.2% of GDP on average after Berlusconi was ousted in 1994. Since he regained power in 2001, he managed to increase it again: book cooking was not enough. (2) The Italian primary surplus was almost 6% of GDP in 2001 when Berlusconi took office: it is now below 1%. (Only about 15% of this is due to the business cycle). (3) Do growing fiscal deficits boost aggregate demand? Not in a “high debtor” country where “non-keynesian” effects are powerful. Italian consumers are now holding their breath (and their spending), remembering the financial crises / tax hikes of the 1990s, thus more than offsetting the growing deficit. Had Berlusconi asked some macroeconomists, they would have told him. But to his coalition (including Mr. Fini), politics is about redistributing, not about promoting growth. (4) As for the supply side, Italy’s “rent seeking” activities are booming … especially within the bureaucracy, that (in the view of the P.M.) exists only to offer his incompetent cronies highly paid sweet jobs. (It was not so in 1996-2000). Something similar could be seen under the soviet communism. Yes, the European Macro management could and should be improved. But Berlusconi and Tremonti have done whatever possible to worsen it. Remember the debate on the Stability pact? For 2 years the whole Europe suggested more fiscal flexibility, to be granted only to low & medium debtors. Greece (the other high debtor) agreed (European growth would have helped high-debtors too); not the Italian government, who blocked any reform, fighting for a license to increase the public debt. Now Tremonti is campaigning against free trade: the populist “vision” is complete. To exit the Euro (and Europe), devaluation, inflation, more debts and deficits, protectionism, a centralised media system, regulation authorities under control, cronyism. So, if Italy exits the Euro, the new currency will not be the “Lira”; it will be called the “Peso”, or something like that! PS. The “gang” may leave the Euro, but will not leave the Euros (about 20% of Italian GDP, net): claims on other European countries’ goods and services… Ah, those holidays in Saint Tropez… In the name of all Italians thank-you, Mr. Berlusconi!
Anonymous • July 30th, 2005 at 9:14 am
Mr. Berlusconi’s government cannot do anything to fix Italy’s problems. This is the reality of democracy. 2 or more groups struggling for power so they can use the limo’s and jets but with no real ability to do anything because the people do not want anything done. This is the reality of an aging society. They do not want to take risks, they do not want large-scale changes and Europeans have been brainwashed into believing that their government can provide for them. This illusion is soon to be broken as the baby boomers age. Since the introdcution of the Euro the price for many goods and services, food, restaurants and housing to name a few, have literally doubled. Is this a coincidence or was the exchange rate set wrong and now the country must absorb the shock as Germany did and is still doing when East and West combined? All the Berlusconi haters will be proven wrong soon. He will lose the next election but Prodi, another ivory tower baffoon from academia, will not be able to accomplish anything. In fact he will worsen the situation. Berlusconi has built an empire. He has created 10s of 1000s of jobs for people. He knows how to make decisions and get things done. He is successful. I will take a successful businessman any day over a professor who has never run a company, never hired or fired anyone, never had to make a tough decision except what to wear and what not to say in public or over an economist who throws stones from a weblog. Be care what you wish for Mr Roubini. I live in Italy and you know not what you speak of. Berlusconi is only repeating what many others around Europe have not the guts to say. The credit-based monetary system is a sham and steals the wealth from the working class while enriching the beaurocrats, elitists and bankers. It is this system and all its bastard children, Euro, Dollar, Yen, etc., that will soon come crashing down.
Anonymous • July 30th, 2005 at 9:25 am
Berlusconi had big dreams when he entered office. Upon winning the forst election the criminal gang from the Left immediately when on the attack trying to get him convicted on 20-year old trumped up charges. They tried to get him to sell off his media business (to the disdain of the workers Berlusconi employs) and they successfully stopped any reform. Politics is not about doing things, it is about winning elections and holding on to power. Mr. Prodi is a professional politician. He will not be able to accomplish anything positive for Italy. He is like America’s Clinton and Bush. Men who have never accomplished anything in private life, or were even complete failures as in the case of G W Bush, but yet the can sell themselves to the ignorant masses and get elected for a few years. Berlusconi did not have a chance. Neither will Prodi. The problems are bigger than just economic reforms. But economists like to think that economic reforms will solve everything. You cannot solve the problem if you do not understand its cause. First the society must hit bottom. Italy, and Europe in general, has not hit bottom. They will soon enough. Wealth production is moving to the East and their is nothing anyone can do to stop hit. This is the way the world has always operated and will continue to do so. The demographic time bomb in the West is ticking and there is no stopping it. Get ready for a lowering of the standard of living. It is unavoidable.
Anonymous • July 30th, 2005 at 3:31 pm
What is striking about Berlusconi fans in this debate is that they don’t feel they should bother about facts… Anything to say about the hard fiscal numbers above? Two economic failures (1994 and 2001-05) are only a mere coincidence? Mocking “economists” and experts (as Berlusconi himself does) is to me a sure recipe for economic mismanagement: apparently not for Berlusconi’s fans! How interesting! Prodi had 6 economic advisors (top italian economists) in his office, Berlusconi had no one until 2005, now he has one but only for the show. Tremonti was not at all an economist, but he though he knew how to manage a modern market economy… Building a bridge without the engineers, building a skyscraper without planning in advance how… This is the problem of Italy: when it comes to managing the public space, competence is not required, facts are uninteresting; only feelings, envy, hate, for or against… matter. This is an ethical crisis!
wphelan0 • July 30th, 2005 at 7:03 pm
I dont see any Berlusconi fans here at all, nor anyone who says that “all” Italian problems were created before 1992, or that some post-1992 governments have not been better than others. The first anonymous has some relevant data on the last point – but my point is that given the underlying problems, many of which certainly largely derive from pre-1992 (like the massive debt stock and the employment rigidities), the likelihood of this situation turning up sooner or later under Berlusconi or some other Prime Minister was very high. Put another way: Given Italy’s history, if Italy’s macroeconomic management had to be permanently as tight as the late 1990s for Italy to make a success of the euro, it would have been wiser not to join.
Anonymous • July 31st, 2005 at 6:29 am
Truly stunning how emotional pro/anti Berlusconi comments are! Given the appalling state of affairs in Italy it is hardly the time nor place to discuss the who & why of this failure! It is virtually commonplace in politics to blame a easily accessible & emotive target to divert from other, more complex topics – and such is the Lira-Euro debate. The cost of the failures of the past have risen almost to the level of suffocation and there is no clean and painless exit anymore. Painful changes are unavoidable, either way. It appears to me that the question of exiting the Euro looks increasingly like grabbing into a falling knife. Italy’s political instability until the recent Berlusconi era seemingly led to an unholy mingling of fiscal and monetary policies until the installment of the ECB. Left only with powers over fiscal policies it is only logic for those living in self-denial to blame the part they cannot control (any more). Internally, problems require most energy & care: e.g. the north-south divide in productivity and economic sustainability or labour markets (to name but two). A Euro exit won’t solve any of these. Rather than focusing pointlessly on individuals & little thought-through comments by these, the attention should be ultimately focused entirely on the core problems & possible solutions. By getting so sidetracked over such apparent beguilement by pre-election rhetoric, most needed attention is wasted.
merugo • July 31st, 2005 at 11:02 am
The sale is off and what remains is simply dump. Everything has been sold in these last 10 years, indulgencies included. Costly and ghostly UMTS licenses were granted for cooking the books to enter in €, and nothing was really used for balancing neither the budget nor the society. An avid oldish population is waiting for blacks to harvest tomatoes, polish for carpenters, ukranians for maidens, free health care, good pensions etc.. Nothing to be surprised if politicians need to divert attention in preelection times. Who rules and who will rule in Italy does not matter. Should Germany produce a continental Tatcher things could change.
Guest • July 31st, 2005 at 12:30 pm
There are a lot of people in Italy who hate Berlusconi just as must as the emotional anonymous poster here. Italy’s problems go back for at least 2 generations. Way too much government involvement. The problem with “economic experts” is that they think that an economy can be “managed.” This is the height of arrogance. We like to say that we live in a “free market economy” but that the free market economy must be “managed.” This arrogance is the root of the problem and it is not just in Italy. A group of economic experts will not help the next PM. Nothing will. Anytime the “experts” get involved Mr Market reminds us of the Law of Unintended Consequences. The other interesting point here is the idea that Berlusconi was a failure in 1994. Less than 12 months in office and he performed no miracles. How sad. When a new government comes into power in any country it can take years for new policies to have any effect thanks to our bloated “democratic” bureaucracies and the bigger the bureaucracy the less overall effect any government can have as it is self serving to everyone in the bureaucracy to maintain the status quo. This is just human nature. But don’t tell this to someone who needs to point the finger of blame at someone who is successful. Stop blaming Berlusconi for Italy’s failures. Why anyone would want the job is beyond me. Its a no win situation. But don’t tell that to statists or economists who think they have all the answers. The same thing will be coming to America in the very near future.
Michael Carroll • July 31st, 2005 at 1:41 pm
I think history will record this as the gloves having come off (spoof!) - …Economic theorists working in the early 21st century discovered that successful monetary integration placed new burdens on governance that various political structures were not equipped to undertake. For example, in the European context, efforts to elevate labor productivity typically conflicted with deep seated cultural biases regarding social entitlements. Under such circumstance, some theorists (Cheney, 2005) emphasized how of periods of disinflation correlated closely with the frequency and intesity of political disputes over the monetary union in-itself. Other theorists supported these notions but, in focussing on the Italian political milue, also brought analytical attention to the quality of governance as a central factor: “Berlusconi is a sleazy crook who made his first financial fortunes by exploiting his political connections to build a media empire and monopoly; so much for free-market neoliberalism!” (Setser, 2005).
Nouriel • July 31st, 2005 at 6:57 pm
This has been a lively debate and certainly Berlusconi has the magnet power of bringing the strongest feelings – negative or positive as they may be – to the fore. No one is arguing here that Italy does not have deep seated problems that go back to the pre-Berlusconi times. But in the late 1990s – when in power – center left coalitions started a series of economic reforms – fiscal adjustment, privatization, social security reforms, start of labor market reforms – that allowed Italy to join EMU and that were going in the right direction. Berlusconi, instead, came to power with alleged neo-liberist ideas but he has done little or nothing to improve the economic performance of Italy. And now, instead of admitting the failure of his own non-policies he is blaming the left and Prodi for Italy’s difficulties by playing the dangerous and ugly anti-euro and anti-EMU card. That is pretty pathetic: the prospect of joining EMU gave the incentives to Italy to pursue the reforms implemented in the 1990s. Interest rates would have been much higher and the public debt dynamics much worse if Italy did not join. While Berlusconi squandered the fiscal rectitude of the 1990s: in spite of record low interest rates thanks to the convergence to EMU rates, fiscal deficits are growing because a large primary surplus has been squandered in the last few years of Berlusconi’s non-policies. This is sad and now Italy’s continued participation to EMU is under threat because of the mediocre policies of his administration and because of the reckless anti-euro rhetoric that is now rearing its ugly head. Whom who wounds by the sword will die by the sword. So, beware those who play with fire. Talk is not cheap as the consequences of anti-euro talk may lead to a self-fullfilling mess. Caveat Emptor!
Guest • August 1st, 2005 at 5:13 am
I suugest Mr Nouriel come over to Italy and see what the reality is. Berlusconi is a magnet for everything that is wrong for many reasons. 1) He is very wealthy and envy is a very strong emotion in Europe. Much more so than in the US. As an American living in Italy I can feel the difference everyday I talk to Europeans. 2) He is very outspoken. He tells you what he thinks and this does not go over well in a world of sleazy, empty politicians like Bush and Blair. Bush could not tell you what he thinks because he is empty inside. A puppet and a complete failure in private business. It is easy to say that Italy should implement reforms and then blame the center right for not getting the job done. The fact is that the people do not want reforms. This is the demographic issue and it will hit the US soon. It has nothing to do with Berlusconi, center-right or center-left. Europe is dying. The Anglo-Saxons are not far behind. Germany has the same problems as Italy and in some ways worse. Many northern Europeans are moving to Italy for retirement. This is causing a boom in housing which then trickles down to consumer goods. Credit is easy. Inflation is roaring. Non of these things have anything to do with Berlusconi. The ECBs policies are much too easy with narrow money growth at 10%. But try selling a house in Germany. You could not. None of my German friends can. There is no market for sellers in Germany. Its dead. Will a Merkel government change this? No. Berlusconi is chanllenging the ECB to get a control of the money supply which is causing the massive inflation here in Italy. The goverment hides the inflation in the statistics just as the US does (we used to call this lying). But all prices have doubled in 5 years. The public debt is growing because of the aging population. Is this Berlusconi’s fault? Get real. I have to say that Mr. Nouriel is just person who needs a scapegoat to point the finger at. The Communists who ran the Italian goverment before Berlusconi left the fiscal condition of the government a complete disaster. This is the reality. Study the history of the Lira. Come on over and see for yourself. Try to start a business. Then try to hire someone. Try to build a house and weave your way through the bureaucracy. The Euro will fail not because of Berlusconi’s talk but because it is a credit-based fiat money. This type of money is doomed to fail since it needs more and more inflation to survive and thus will hyperinflate and then collapse as the people lose confidence. It is money based on nothing that steals the wealth of the working man while enriching the bankers and politicians. Central banking is anti-freedom as it puts too much power in too few hands. This is where the real problems lie. But it is easy to ignore the reality of the credit-money system and blame some rich dude.
Guest • August 1st, 2005 at 5:18 am
One more thing sir. When you come for a visit to Italy you can talk to the locals and you’ll see that they too want to return the the Lira. But then you would say that they are being “dangerous” and “reckless” no?
Guest • August 2nd, 2005 at 1:38 am
According to Socrates (469-399 B.C.E.), the first step in knowledge is “knowing of not knowing”. According to my vocabulary, “arrogance” is synonymous of: Idiocy – Incompetence – Insanity – Megalomaniacal Maxims. In a comment above, someone accuses “experts” of arrogance; and states that “arrogance” is the main problem. I agree with the latter part of that statement only. Peace to everybody.
Guest • August 2nd, 2005 at 5:03 am
The issue in Italy is not with Berlusconi. Mr. Berlusconi has not accomplished his “neo-liberal” agenda, that is true. But that is not his fault it is the fault of democracy in general. President Bush cannot accomplish his big goals of Social Security and Income Tax reform either. Why not? Bush has control of both houses of Congress. Maybe democracy is more difficult than is given credit? The fact is democracy is a poor system of goverment. Mr. Berlusconi, to his credit, has held the government in Italy together longer than any Prime Minister in the post-war period. This in itself is a major accomplishment in a country that had 50 governments in 45 years. The Euro as a currency will fail. Berlusconi, who cannot get through his neo-liberal agenda, will also not be able to get Italy to leave the Euro currency. If he does not have the power to change a few labor laws, how could he ditch the Euro when so much is riding on its success? I think Mr. Roubini is just using this outburst by Berlusconi to attack him as a symbol of new-liberalism without understanding the bigger picture. Europe is dying and there is nothing anyone can do about it. As Mr. Roubini points out, the costs of leaving the Euro currency could be devastating. But it will happen. Maybe in Italy first. Maybe in Germany. Europe is in serious trouble.
Paolo • August 2nd, 2005 at 5:36 pm
Hi Nouriel, I wish you had not attached these incendiary and offensive comments about Berlusconi to your analysis of the economic situation in Italy (e.g., “Berlusconi is a sleazy crook who made his first financial fortunes by exploiting his political connections to build a media empire” etc. etc…). As economists, we should stay above the fray and discuss facts and policies (as you actually do in most of your editorial) in a calm and respectful manner rather than letting our passions take hold of our pen. I am sure you would have not made that comment when writing a paper criticizing the work of a colleague.
Guest • August 2nd, 2005 at 7:23 pm
On the contrary, we economists cannot always stay in the ivory tower as if the real world was not our care. There are moments in history when you have to come forth, and say the truth. It’s the truth that is offensive and incendiary: Italy is burning slowly but surely. Nouriel is only warning that the flames may become much higher (and broaden) if Berlusconi goes on like this. The “sleazy crook” comment is not only true, but also to the point in this context: the point being that (1) Berlusconi is not pursuing reforms and thus (2) is covering up his empty action with dangerous anti EU rhetoric because (3) he cares more for his power and thus (4) for ill-conceived redistributive politics than for the common good (deficits + devaluation + inflation is the populist way to tax without showing it to the people), as (5) his life and the friends that he chooses (not very transparent) show. Economists must say the truth about economics, or they are useless. I wish more such “incendiary” comments were made in Germany in 1933 or about Stalinism in 1948 in Eastern Europe. History never repeats, it’s true (I hope): but Europe today is at a turning point, severely threatened (by whom? your choice!) and yes, in need of reform. And the E.U. is indeed important, to maintain peace in Europe (take a look at its borders, Balkans, Belarus, Russia, and at History), and to deal effectively with emerging global problems that are affecting our daily lives more and more. Berlusconi is attacking the very fundamentals of our common life: our institutions (the Euro is one); and not with a will to improve them or with an alternative sound vision to suggest, but to cover up his own trade. Berlusconi is incendiary, not Nouriel. Kind Paolo, I also love peace, and would like to have a peaceful life with no arguments. But it is the task of intellectuals (Nouriel is one) to see ahead, in the future, and warn BEFORE ugly things happen. And Nouriel concerns are grave, so his words sound rash to many: after all, many of us hoped that Berlusconi could introduce the much needed reforms that a paralysed left couldn’t do (remember Cofferati in 1999?) To admit now that we were mistaken is painful enough. And Berlusconi’s language often seems fluted and sweet, full of promise for the future. But Nouriel’s language is alas entirely appropriate, and Berlusconi’s is deceptive. If we would all awake and tell clearly to Berlusconi that what he’s doing with the Euro is unacceptable, then maybe people like Nouriel would not need to use such strong expressions. Peace to everybody Gandalf
Guest • August 3rd, 2005 at 7:11 am
P.S. This morning, in the Financial Times, Adam Posen states that “Europe must again confront the forces of illiberalism”, analyses the economic roots of illiberalism, and (sadly but convincingly) parallels the 1930s to the current Age. He never mentions Berlusconi of course (B. is of course only one of the many populist products of our time); but in Posen’s characterisation of some worrisome current trends one may well recognise some of Berlusconi’s economic approaches. G.
Niccolo • August 3rd, 2005 at 2:47 pm
It is disappointing and very Italian that what began as an intersting analysis (apart from the violent personal accusations against Berlusconi) has lead to a brawl and confused shouting match. The real point is not Berlusconi, who clearly can no longer even control the coalition let alone the country, but Italy’s institutions and society. It is wrong to focus on single individuals and sentiments. Italy needs more bipartisan spirit and a serious analysis of how its economy can change to face globalisation. It needs to abandon its crony capitalism and personal bickering, for it is being torn apart by conflicts between special interests none of which want to renounce their privileges. Lets go beyond the “structural reforms” catch phrase and discuss more in detail what needs to be done. PS By the way I believ Prof Roubini knows Italy well having studied at Bocconi University in Milan.
Guest • August 3rd, 2005 at 11:49 pm
Before I got half way thru your article the words “capital flight” came to mind. What would the Italians with Euros do if the Lira was reintroduced?
Guest • August 6th, 2005 at 10:26 pm
Yeah, “what would the Italians with Euros do if the Lira was reintroduced?” Good question! In the simplest case where only Italy quits, and nothing else changes, there are two scenarios (they don’t differ much in their implications). A) The government of Italy announces a “parity” between the Euros and the new Lira: for ex., 1E = 2000L. Then it prints New Liras and offers 2000 “New Liras” for any Euro (that the population is willing to exchange with the Italian Government). The Italian Government also announces that starting from DAY X all transactions in Italy will have to be made in Liras (whoever does not comply will be fined or jailed). So the Italian population brings (part of) its Euros to the Italian government, takes the liras in exchange, and life in Italy resumes as in the “good old days”. Except that now the Italian government is rich. It has a lot of Euros (15% of GDP?), a good and valuable currency, which can be used to buy German or French products, to buy back Italian Gov. bonds (debts) denominated in Euro, or even buy German bonds, to use their yield to finance the Italian public debt service. Europe may try ask the Euros back; but the Italian government could understate the Euros received by the population, and hand back to Europe only a minor fraction of them. And the trick is done! He he! Scenario B The Italian government announces that it will give 2000L. for any Euro that the population will bring to the Italian Central Bank before DAY X, but also that one month after DAY X it will give (all) the Euros back to their ancient owners. This is the “holydays in Saint Tropez free for everybody” scenario mentioned in a comment above. In this scenario, Italians are suddenly “rich”: in one month they double the money they have in their pockets. [If they had 100E. now they have M = 100E. + (100*2000)L.] Where does this sudden wealth comes from? From Europe. Of course, Europeans would not be happy about this wealth transfer to Italy, but Italian citizens (institutions) cannot be forced, in practical terms, not even by their own government, to hand the money back. The redistribution effects of a unilateral dump of the common currency are well known (and feared) by the European Central Bank. That is why the E.C.B. insists that leaving the Euro is “not an option”. Actually, the possibility that a rogue Balkanic state would join the Euro, receive the monetary base from the E.C.B., then leave the Euro keeping the Euro monetary base was discussed behind closed doors in 1997-98. But now…Surprise! It is not Montenegro who threatens to commit the greatest robbery of the century: it’s Italy! He he! So leaving the Euro implies keeping in Italy, in one way or another, most of the Euros. With these Euros, Italians can now claim a surplus of foreign goods. “Italy dumping the Euro” implies a burst of demand (and inflation) both in Europe (too many Euros around compared with the now smaller Euro currency area) and in Italy (here it’s the wealth effect at work). It’s Berlusconi’s solution to the low growth problem in Europe! He he! Now a few final remarks on the debate on language. Nouriel’s blog was not about the problems of Italy and “how its economy can change to face globalisation”, but about the Euro. What currency should Italy use? And why Berlusconi hates the Euro? What country will Italy become if it leaves the Euro: do we like it? Or else, what should be done in order to stay in the EMU and prosper? We need a political economy analysis, however unpleasant (not a “brawl and confused shouting match”), because it is essential to understand what is going on right now in Italy. In this respect, it is fair to say, analytically, that “Dumping the Euro” is an idea totally consistent with the previous (2002-2004) Italian government pressure to blow up the Stability Pact, to raise the Italian deficit beyond 3% of GDP. (Berlusconi finally obtained this in March 2005). Beyond 3%… we are now at 5%. Crazy, with all the debts we already have no? No! My barber wanders “why should we worry, given that Italy’s public debt has been growing for 40 years without causing any problem?”. So Berlusconi seems to think about the public debt just as my barber does. Unfortunately, at 5% of GDP the process of deficit expansion faces new constraints: Europe again, and the markets, who will not finance our debts forever, as Berlusconi is being told by the Treasury. (Oooh! They just don’t “let him work”!) So: how could he further increase public expenditure (that’s basically how the Berlusconi deficit was created), without of course openly taxing Italians? Or parade with another round of “tax cuts” when he has no funds? Simple. Have your own currency, print it, devaluate (“to regain competitiveness, uh?!), inflate. Devaluation and inflation are (hidden) taxes on money balances (we pay); they can finance many deficits, and erode the real value of many debts. Berlusconi, leaving the Euro, will be free to increase this very regressive and inefficient hidden tax, and obtain further degrees of freedom in the use of public resources. How will he use the money extracted from the private sector? As he is using it now: for his cronies or protected groups, leaving peanuts for his populist propaganda. After 4 years, I don’t see any great investment around. Harsh words? Sorry folks, if you think that this is leftist propaganda just take a closer look at what is going on inside the public sector, and you will see that the corruption is unprecedented. (And yours truly is anti-communist to the bones.) So with the Lira, no more political and financial problems. An endless stream of money will be ready for distribution by the government, to appease every one (making at the same time everyone more dependent upon political friends). There will not be Europe anymore: our currency, we just print it. Don’t cry for me, Italietta… Gandalf
Guest • October 19th, 2005 at 6:26 pm
To understanding better Italian policy… Beppe Grillo’s blog now also in English Beppe Grillo is a top Italian comic, famous for being politically outspoken in his shows. He is considered the Italian Michael Moore. Expelled from Italian TV (under Italian premier Berlusconi’s control), he created a popular blog, where he writes his opinions every day. Grillo’s blog is now also in English language: http://www.beppegrillo.it/eng/
