This week has seen the revival of talk about a subject which has done the rounds before. It would also appear that you cannot keep Silvio Berlusconi down as he was the person bringing it back into the news! Here is what was put forwards according to the Financial Times.
Berlusconi said the right-wing Lega Nord’s proposal of introducing the so-called ‘mini-BoT’ (short-term, interest-free, small-sized government securities, a sort of ‘IOUs’ to be used as internal currency to pay government suppliers, taxes, social security contributions, etc) would not be too far from his idea of a parallel currency.
There are quite a few issues here but let us stick to the obvious question which is could it happen? The FT again.
Berlusconi’s point then is that a parallel currency could be launched entirely legally within the constructs of European treaties, with the ECB potentially powerless to intervene once the decision has been taken.
Either way, regardless of whether Italy goes down the path of an explicit parallel currency or the introduction of small-sized Italian government securities, it’s clear the will to break up the euro’s monopoly in Italy is growing.
According to Citi’s analysts more than two thirds of Italian voters currently support parties with an anti-euro stance.
An interesting view although of course likely to cause something of an Italian turf war as the current President of the ECB Mario Draghi told us this in July 2012.
And so we view this, and I do not think we are unbiased observers, we think the euro is irreversible. And it’s not an empty word now, because I preceded saying exactly what actions have been made, are being made to make it irreversible.
Of course the speech went further with the by now famous phrase below.
Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.
So there would be an especial irony should it be that Mario’s home country ends up torpedoing the whole project. Perhaps that is why his speech this morning refers back to 2012.
Investors had begun pricing redenomination risk into sovereign debt and interbank markets, as they worried about the possible break-up of the euro area.
And reminds us of his “Jedi Mind Trick” from back then.
This is why we announced Outright Monetary Transactions (OMTs) as an instrument that can support our monetary policy. The idea was for the ECB to purchase the sovereign bonds of countries affected by panic-based redenomination risk.
This brings us back to this week where Italian bond yields rose in response to such risk but only to 2.1% for the ten-year as I type this. So some 5% lower than the time of the Euro crisis and those selling Italian bonds would most likely be selling them to the bond buyers of the ECB. So in that sense Mario has played something of a blinder here especially if we allow for the fact that going forwards the ECB may purchase such bonds disproportionately ( partly because it is running out of German bonds to buy).
Some care is needed as on the face of it there is only one winner which is the “whatever it takes” ECB. But take care because if we dive a little deeper there is the issue of the ECB being backed by 19 different treasuries including the Italian one. What if people started to believe it would no longer be one of them? What would the other treasuries think about owning lots of Italian government bonds ( 283.7 billion Euros)? It would make the discussions with the UK look like a tea party.
How did this begin?
In essence the parallel currency thoughts came out of this summarised by Roubini’s Economonitor in July 2014.
Since 2008, Italy’s industrial production has shrunk 25 per cent. In the last quarter of 2013, while exports reached back to almost the same level as in 2007, household consumption was down by about 8 per cent and investment by 26 per cent, with a capacity loss in manufacturing hovering around 15 per cent. Between 2007-2013 employment fell by more than a million, and the unemployment rate more than doubled (Banca d’Italia 2014a).
So we have the issue of Italian economic underperformance which regular readers will be well aware of. Not only was economic output below that below the credit crunch peak it went below the level of the year 2000. On an individual level the position was in fact even worse as the population has grown in the Euro area and I recall calculating that economic output ( GDP) per head was in fact 7% lower than in 2000.
What about now?
Whilst the specific numbers this morning were for France and Germany the Markit PMI business survey hinted at more growth for Italy.
The rest of the eurozone saw a slightly weaker increase in output during the month, albeit one that was still marked. A slower rise in services activity outweighed stronger growth of manufacturing output.
This adds to last weeks official release.
In the second quarter of 2017 the seasonally and calendar adjusted, chained volume measure of Gross Domestic Product (GDP) increased by 0.4 per cent with respect to the first quarter of 2017 and by 1.5 per cent in comparison with the second quarter of 2016.
So we find an irony in that the parallel currency has been revived when Italy is doing better economically. The catch is that if we move to the individual experience and look at GDP per inhabitant we see the underling issue. In 2007 GDP per individual was 28.699 Euros and in 2016 it was 25876 Euros in 2010 prices.
There is a fair bit to consider here and the first is that parallel currencies are usually not approved by the government and may even be restricted or made illegal. Usually it is the US Dollar being used due to a loss of faith in the national currency although in an irony some places could use the Euro. We saw an example of the US Dollar being used in Ukraine for example. So the crux of the matter in many ways would be what would be legal tender in Italy going forwards and as someone observed when we looked at Bitcoin can it be used to pay taxes? Presumably this time the answer to the latter would be yes.
Next comes the interrelated issues of capital flight and currency depreciation or devaluation. I think that it is clear that large sums would leave Italy which poses the issue of whether a 1:1 exchange-rate could be maintained and for how long? I see no mention for example of what the official interest-rate would be? Moving onto debts such as bank debt and Italian government bonds or BTPs in theory the ECB could insist on repayment in Euros but in practice we come to the famous quote from Joseph Stalin.
“How many divisions does the Pope of Rome have?”
In the end it comes down to the words fiat and and faith. The first is easy as the government can make a law but will people not only have faith but really believe? Also in a way it is something of a side show ( Bob) because both pre and during the Euro what Italy has needed is reform and of course neither has delivered it. Mario Draghi reminds us of this at every ECB press conference.