Will Italy get a 250 billion Euro debt write-off from the ECB?

Up until now financial markets have been very sanguine about the coalition talks and arrangements in Italy. I thought it was something of calm before the storm especially as these days something which was a key metric or measure – bond yields – has been given a good dose of morphine by the QE purchases of the European Central Bank. However here is a  tweet from Ferdinando Guigliano  based on information from the Huffington Post which caught everyone’s attention.

1) Five Star and the League expect the to forgive 250 billion euros in Italian bonds bought via quantitative easing, in order to bring down Italy’s debt.

My first thought is that is a bit small as whilst that is a lot of money Italy has a national debt of 2263 billion Euros or 131.8% of its GDP or Gross Domestic Product according to Eurostat. So afterwards it would be some 2213 billion or 117% of GDP which does not seem an enormous difference. Yes it does bring it below the original 120% of GDP target that the Euro area opened its crisis management with but seems hardly likely to be an objective now as frankly that sank without trace. Perhaps they have thoughts for spending that sort of amount and that has driven the number chosen.

Could this happen?

As a matter of mathematics yes because the ECB via the Bank of Italy holds some 368 billion Euros and rising of Italian government bonds and of course rising. However this crosses a monetary policy Rubicon as this would be what is called monetary financing and that is against the rules and as we are regularly told by Mario Draghi the ECB is a “rules based organisation”. Here is Article 123 of the Lisbon Treaty and the emphasis is mine.

Overdraft facilities or any other type of credit facility with the European Central Bank or with the central banks of the Member States (hereinafter referred to as ‘national central banks’) in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the European Central Bank or national central banks of debt instruments.

Now we hit what Paul Simon would call “troubled water” as the ECB has of course been very close to the highlighted part. The argument for QE purchases rested on the argument that buying in the secondary market was indirect and not direct or as the ECB puts it.

There will be no primary market purchases under the PSPP, regardless of the type of security, as such purchases are not allowed under Article 123 of the Treaty on the Functioning of the European Union.

It is a bit unclear as to when they become available but if I recall correctly as an example the Bank of England limit is one week.

The reason for this is to stop a national government issuing debt and the central bank immediately buying it would be a clear example of round-tripping. The immediate implication would be a higher money supply raising domestic inflation dangers  although there would be an initial boost to the economy. We did look at an example of this a couple of years ago in the case of Ghana and whilst we never get a test tube example in economics the Cedi then fell a substantial amount and inflation rose . Thus the two worrying implications are inflation and a currency plunge on a scale to cause an economic crisis.

Would this happen in the case of Italy? That depends on how it plays out. Inside the boundaries of the Euro maybe not to a  great extent initially but as it played out there would be an effect as Italy would not doubt be back for “More,More,More” once Pandora’s Box was open and of course others would want to get their fingers in the cookie jar.

Oh and if we go back to the concept of the ECB being a “rules based organisation” that is something that is until it breaks them as we have learnt over time.

Fiscal Policy

You will not be surprised to learn that they wish to take advantage of the windfall. Back to the tweets of Ferdinando Guigliano

5) The draft agreement would see the Italian government spend 17 billion euros a year on a “citizens’ income”. The European Commission would contribute spending 20% of the European Social Fund

That raises a wry smile as we mull the idea of them trying to get the European Commission to pay for at least some of this. Perhaps they are thinking of the example of Donald Trump and his wall although so far that has been more of a case of a “Mexicant” than a “Mexican.”

Next came this.

According to , the 5 Star/League draft document says there would be a “flat tax”… but with several tax rates and deductions

So flat but not flat well this is Italy! Also we see what has become a more popular refrain in this era of austerity.

Italy’s pension reform would be dismantled: workers would be able to retire when the sum of their retirement age and years of contribution is at least 100.

Over time this would be the most damaging factor as we get a drip feed that builds and builds especially at a time of demographic problems such as an aging population.

So a fiscal relaxation which would require some changes in the rules of the European Union.

The two parties want to re-open European Treaties and to “radically reform” the stability and growth pact. The coalition would also want to reconsider Italy’s contribution to the EU budget.

Market Response

That has since reduced partly because the German bond market has rallied. Partly that is luck but there is an odd factor at play here. You might think that as the likely paymaster of all this Germany would see its bonds hit but the reality is that it is seen as something of a safe haven which outplays the former factor. On that road it issued some two-year debt yesterday with investors paying it around 0.5% per annum. Also I think there is such a shock factor here that it takes a while for the human mind to take it in especially after all the QE anaesthetic.

The Euro has pretty much ignored all of this as I use the rate against the Yen as a benchmark and it has basically gone “m’eh” as has most of the others so far.

Comment

There are quite a few factors at play here and no doubt there will be ch-ch-changes along the way. But the rhetoric at least has been raised a notch this morning.

We are in favor of a consultative referendum on the euro. It might be a good idea to have two euros, for two more homogeneous economical regions. One for northern Europe and one for southern Europe. ( Beppe Grillo in Newsweek)

I do not that the BBC and Bloomberg have gone into overdrive with the use of the word “populists” as I mull how you win an election otherwise? If we stick to our economics beat this is plainly a response of sorts to the ongoing economic depression in Italy in the Euro era. Also it was only on Monday when the Italian head of the ECB was asking for supra national fiscal policy. For whom exactly? Now we see Italy pushing for what we might call more fiscal space.

Meanwhile if we look wider we see yet more evidence of an economic slow down in 2018 so far.

Japan GDP suffers first contraction since 2015

Very painful for the Japanese owned Financial Times to print that although just as a reminder Japan is one of the worst at producing preliminary numbers.

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24 thoughts on “Will Italy get a 250 billion Euro debt write-off from the ECB?

  1. Yes I have noted the increased misuse of the term ‘Populist’. It essentially means a political agenda that the EU and liberal elite don’t agree with. Another entry for your Lexicon?

    • The attitude of the elite to populism seems to be a mixture of:
      1. Try to get these ghastly people to vote for what we like by, say, Project Fear or, in Eastern Europe, threatening withdrawal of European subsidies or, in Greece, just straight threats
      2. When the same awful people actually win a vote, start insulting them as uneducated, misinformed, incapable of understanding the issues etc
      3. Use every trick in the book to pretend that you are listening to the aforesaid vote, while undermining the process at every stage (House of Lords votes)
      4. Make them vote again if 3 does not work (such as the various lost referendums in Ireland/Denmark)
      5. If 4 is impossible (European constitution turned down by France and Holland), find a way of getting the elite way while not letting these dreadful people vote again (the Lisbon Treaty)
      6. If something serious goes wrong (Brexit), then immediately try to find ways of other countries having a refendum.
      And, then, the elite is amazed that the plebs don’t like this treatment – they should be pleased that their betters are in charge.
      You can almost hear the sneer at the word populist…

  2. Is it not interesting that the possibility of a “populist” government(that is a net recipient of EU funds) in Italy that might leave the EU, is being considered for a bribe of 250 million euros in order to effectively stay in, whereas the UK()a net contributor) has voted to leave and is being presented with a bill of anything up to £80 billion and a whole host of conditions that effectively amount to us remaining in the customs union and accepting free movement of terrorists, and remaining under the control of the European Courts, in other words leaving in name only but effectively still IN.

    But then the EU knows the UK government -regardless of which party is elected- is so (in order)corruptible, naieve and incompetent that BREXIT never stands a chance, the Italian Five Star/League probably less so.
    As Shaun points out, this blackmail will be copied by others, and like all blackmailers, they never take just one payment and go away do they?

    • Hi Kevin

      The same is true on the other side as the European Union or Euro area indulge in threats bullying and blackmail. The classic case of this was with Greece where the supposedly revolutionary government ended up folding like a deck chair. I do not understanding the lauding of Yanis Varoufakis who played his part in the ordinary Greek being made even poorer.

      So the EU establishment after that “success” is playing the same game with the UK and will no doubt try it with Italy.

  3. The EU seem to be permanently wedded to the one-size-fits-all structure of the euro and interest rates when it plainly doesn’t work. The poor countries (Greece and Italy) will never get out of the doldrums unless there is some kind of fiscal transfer from the rich countries (Germany).

    • Hi Jan

      In essence that is their dream project which is the Euro. The rub as you say is that the promised economic convergence never happened and there seems little prospect of anything being done to change that.

  4. Apologies the above should read 250billion -not million, also Five Star promised 780 euros a month Universal Basic Income if it got into power.There has already been multiple enquiries at local job centres for it, even though no government has been formed yet.

  5. Hello Shaun,

    Very dangerous waters – if Italy does get a write off – who will explain it to the Greeks or the Spanish ? yet alone the German tax payer

    and a reduction in contributions ? Again lets not worry about the UK because everyone here would be expected to be aghast at that even if we were staying in the EU .

    so just a ploy ?

    solutions to drop from the Euro and stay in the EU or go for a Canada deal ?

    The game is hotting up for those trying to keep the whole project running – I expect there will be someone being “creative” in the back ground 🙂 ( just like with CDS eheheheh )

    Forbin

    • Hi Forbin,
      Rule nothing too insane out, there is even talk of Italy having two currencies as a “temporary” solution, bailouts will always be explained away after constantly being denied.

      • hi kevin

        the euro is like hotel California – you can never leave …….

        I expect a push to full financial integration because just like the UK in that everyone need England to bail them , the Euroland needs Germany …

        how long before Germany is sunk under the massive debt mountain of the south ?

        reparations for WWII will be hinted again , like Greece did – oh deary me !

        Forbin

        • I forget who it was, but one of the founders of the EU (I think that it was Jean Monnet, but may be wrong) said that the way to create a real federal Europe was to:
          1. Integrate things on the sly so that, by the time people noticed, it was a fait accompli
          2. Use every crisis to push for more integration.
          So, I would expect Brussels to push for much closer union. As you say, though, at what stage does Germany stop Brussels? Imagine, if Germany underwrites the current debts of Italy/Spain etc. Do you think that Italy will then become a model of fiscal rectitude? I think that, instead, they will think that Xmas has come easily and spend away. Therefore, it can only happen if the whole system is unified such that Germany could then prevent southern overspending.

          • hello james,

            “Do you think that Italy will then become a model of fiscal rectitude?”

            rectitude? hmmm more like rectum , as in Germany getting shafted ( and Finland and the UK if we dilly and dally ) …

            oh deary me ..

            Forbin

  6. While the ECB could write off the Italian debt:
    1. Its balance sheet would be in pretty dire shape
    2. The immediate demands by all others with ECB-held bonds to do the same as Italy, would bust it, I think
    I guess that, at that point, Germany would have to hold the whole thing up and call it the Bundesbank or watch the euro die.

    • Hi James

      There is also the issue that the money will have been created permanently as funds paid to buy the bonds are now in the system. So a monetary expansion. Central bankers claim that sort of thing is easy to drain and in theory it is but in practice we have seen many theories of their come a cropper.

  7. It is amazing how one aspect of politics has crossed the Atlantic. You put two implacable enemies together (Republicans and Democrats or Five star and the Lega) and they produce a so-called budget where both sides ask for and get almost everything and the deficit rockets…
    We live in interesting economic times

  8. As US Treasury yields have reached their highest level in 7 years, I cannot see the Germans bailing the freckless Italians out this time. Italy will posture like Mussolini and threaten to leave the euro, but life with the lira will not be as easy as these populists claim.

    • Dave ,

      the French will want the Germans to bail out the Italians ( and the Spanish , Greeks, Ireland, Portugal , etc, etc)

      but can they ?

      Forbin

  9. The point about “populism” is that it is popular & in a democracy that which is popular should prevail. The problem with this is that “something for nothing” is very popular. If the

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