August 8, 2011
You know the feeling when you get a text and have to look at it twice to make sure that what you are reading is what you just thought you read.
On Friday morning, I got a message from a friend who was caught in a huge midsummer traffic jam at the Swiss border coming from a family holiday in Italy.
On the main road out of Milan to Lugano in Switzerland, the Italian police, under instruction from the Guardia di Finanza, were stopping everyone.
They were searching all cars, trucks and vans for money – actual wads of euros – because ordinary Italians are now moving their money to Switzerland.
They are panicking. This has always been the case in Italy. At the first hint of a financial crisis, they head with their savings up the road to Switzerland.
When a financial crisis moves from the relatively opaque trading rooms of investment banks to the ordinary people, you know you’re in trouble. In Italy we are seeing not just a run on a bank; this is a run on a country.
Two weeks ago this column opened with the following words: ‘‘Let’s be clear.
The European deal announced last Thursday night is designed to do one thing and one thing only. It is designed to persuade investors to buy Italian and Spanish government bonds.” I thought this deal would fail, but had no idea that it would be blown out of the water quite so quickly.
Now even the average punter is moving His money out of Italy and Spain.
This makes a mockery of the likes of Olli Rehn and the rest of the European elite who claim that the ‘fundamentals’ are strong and that everyone is overreacting.
When you look at the fundamentals, you see that the picture is actually quite frightening and people are right to be cautious.
Italy has a debt stock of 120 per cent of GDP. This accounts for 23 per cent of all eurozone sovereign debt and it needs to be rolled over constantly.
At an interest rate of 2 or 3 per cent, that might be manageable. But at an interest rate above 6 per cent, it becomes an entirely different story.
The problem for Italy is that it has to keep refinancing, even though its budget deficit, at less than 4 per cent of GDP, is among the lowest in the eurozone.
Without debt payments it is running a budget surplus, so it can’t be regarded as being fiscally irresponsible, but when the rate of interest on its debt rises, you begin to see what could happen.
Next year, Italy will need to raise an amount equivalent to 20 per cent of GDP simply to refinance all the debt that is due.
This figure is from the IMF and the bad news is that at 20 per cent of GDP Italy, in relative terms, needs to raise more debt as a percentage of GDP than even Greece.
Suddenly, as interest rates rise, Italy becomes a big – really big -Greece.
But forget Italy’s problems next year and consider what it has to finance in what is left of this year.
Before Christmas, Italy needs to raise â‚¬237 billion – and another â‚¬296 billion in 2012.
So now you see the euro’s debt problem and how it is spinning out of control. Either the markets finance this – and this week they are signalling that they are only prepared to give the Italians money at above 6 per cent – or someone else has to buy Italian government debt.
That other source of money is the German taxpayer, who from now on everyone assumes will be Europe’s lender of last resort.
This assumption that the Germans will pay is what is driving down Irish bond yields too because certain people are making the bet – a reasonably logical one based on past performance – that Germany will pay. If you believe that the Germans will pay in the end, you might as well sell Spanish and Italian bonds and buy Irish bonds, which are much cheaper because, ultimately, Gunther will bail us all out.
But what if Gunther doesn’t see it this way? What if he says ‘genug’ (enough!)? What if, sitting in his kneipe over a litre of frothy local Weissbier on his parsimonious annual two-week camping holiday in the Schwarzwald, Gunther says: ‘‘Hold on, we can finance the Greeks and maybe the Irish, but the Italians that’s another case.” What do we do then?
Then we must consider plan B.
Already central banks all over the world are making alternative plans.
They are hedging in the age-old fashion – they are buying gold like never before. Central banks are ramping up their gold-buying as they seek to diversify their reserves away from the euro and, of course, the dollar. South Korea became the latest government to disclose a big bullion purchase, saying that it recently bought 25 metric tonnes, more than doubling its holdings to 39 metric tonnes.
Mexico, Russia and Thailand have also been major buyers in 2011.
This year, governments have almost trebled their net gold purchases, increasing their holdings by 203.5 metric tonnes this year, up from a 76 metric tonne rise last year.
Before this year, governments had on balance been shedding their bullion for two decades, during which gold was seen as a relic, with 1988 being the last year that official holdings increased.
Now all that has changed and will continue to change. In short, other central banks are betting that Gunther will not pay and that something will happen to the euro.
Clearly they are betting against the dollar too, but for us Europeans Gunther’s next move is what we are focused on. So let’s see what might happen.
Plan A is based on the notion that the Italians, Spanish, Greeks, Irish and Portuguese will all run huge budget surpluses to pay creditors – in most cases, foreign creditors. This is hardly politically plausible, for a variety of reasons, the main one being that growth, such as it is, will disappear.
Without growth all bets are off, and politicians know that.
Plan A is also predicated on the notion that if we get fed up of running budget surpluses, Gunther will step in and bail us all out.
This is also reasonably implausible.
Why mightn’t Germany do what it did in the 1993 currency crisis, when Germany undertook to buy all French government assets to protect the battered French franc?
Germany didn’t wade in like this for anyone else. All other embattled currencies devalued.
The Franco/German arrangement was described by Bertie Ahern at the time, as a ‘‘sweetheart deal’’, but it was much more than that. It underscored what being at the ‘heart’ of Europe means – it means Germany and France and when push comes to shove, that’s it.
What if, when this debt crisis threatens France, as it will, the Germans say they will help France but no one else?
What if they realise that the reason the markets are selling Italian bonds is because there is no Italian currency to sell? If there were a currency to sell, the markets would express their scepticism about Italian economic policy by selling the currency.
If this were the case, German savers would be insulated from the delinquency of the Italians and others. What if they were to figure this out?
What if they were to come to the conclusion that either they underwrite everything in the euro and thus put themselves on the hook for all of us, or the euro goes and they are off the hook?
This hot August, somewhere in Bavaria, Gunther has a lot to think about as he barbecues his bratwurst over the holiday campfire.
Meanwhile, Guido isn’t waiting around as he bolts for Zurich with his swag.