December 12, 2016
A few weeks ago, I stayed in the Grand Hotel in Rimini. This place has real significance for Italian movie lovers because this was the base camp for the brilliant Italian director Federico Fellini.
Not only did Fellini use the Grand Hotel in Rimini as his set, but he died there too, in the suite upstairs that he used as his office.
Fellini loved the absurd, the ridiculous. His movies, with their outrageous casts of Italian eccentrics, captured the booming, confident Italy of the 1950s, 1960s, 1970s and 1980s. In many ways, Fellini was post-war Italy’s scriptwriter.
But Fellini’s Italy is gone.
Italians are naturally nostalgic for that booming post-war period of nearly 50 years’ growth when Italy was rich, when mass immigration wasn’t an issue and when Italian produce was sold all around the world.
Sometimes it is not appreciated quite how industrial Italy is. It has long been Europe’s second-biggest manufacturing power, beaten only by Germany. In some areas of design and high-quality manufacturing, Italy is still without peer.
However, since it gave up the lira and adopted the euro – in effect Germany’s currency – things have gone pear-shaped.
From 1945 to 1995, there was an understanding that Italy would devalue the lira. This is what Italy did. Traditionally, it devalued the lira every few years. This was expected and it kept Italian industry competitive.
So, for example, when Italy joined the EMS in 1979, the exchange rate was 443 lira per deutsche mark. By 1990, the year of German reunification, the rate was 750 lira to the deutsche mark. By 1995 it was 1,000 lira to the deutsche mark.
In the 1992 currency crisis the lira fell to a low of 1,250 against the deutsche mark before recovering a bit.
The gradual fall in the value of the lira was a price that the Italians were prepared to pay for industrial success. Contrary to the dogma spouted by Europe’s central bankers, Italian devaluations worked particularly well.
Just look at the numbers.
From 1979 to 1998, Italian industrial production outpaced that of Germany by more than 10 per cent. Italian equities outperformed German equivalents by 16 per cent – after having taken into account the devaluations.
So not only was Italian industry growing faster than German industry, aided by lira devaluations, but also the return on capital in Italy was higher than Germany.
This is because if the stock market of a country is outperforming another, it implies that the capital that is deployed in the faster growing country is being deployed more efficiently. Therefore, not only was Italy growing faster than Germany, but it was more efficient too.
Then came the euro.
Since Italy joined the euro, almost to the day, Italian industry has gone backwards. Having outperformed German stocks during the period of the lira, Italian stocks have underperformed German stocks by a whopping, bankruptcy-inducing 65 per cent.
During the half-century when Fellini was writing the story of post-war Italian success, the Italian stock market almost always returned more than the German stock market. Once Italy joined the euro that stopped almost overnight.
Deep in the economy, the strictures imposed by the euro have destroyed much of Italian industry. For example, having outgrown Germany’s industrial output in the 1980s and 90s by 10 per cent, Italian factory output since Italy joined the euro has lagged Germany’s by 40 per cent.
This is an extraordinary reversal of the previous 50 years.
While German industrial might has solidified in the euro, Italy has become enfeebled. For example, almost one manufacturing firm in five in Italy shut down between 2009 and 2012.
Production is now 26 per cent below 2007’s peak.
In short, Italian competitiveness has been decimated by the euro. Without devaluations, Italian industry has floundered. Either a country’s currency adjusts if it is not as competitive as its neighbour, or it goes out of business. Italy is gradually going out of business.
Now think about Italian banks and Italian debt. Italy has the largest debt/GDP ratio in Europe at 130 per cent and its banks are extremely weak. The EU knows that if Italy’s banking crisis is not managed properly, there will be contagion across the entire eurozone. So Frankfurt is nervous.
On Thursday, the ECB extended its “delay and pray” policy of buying up every asset that isn’t nailed down. It announced that it would extend quantitative easing until next December. This means that it will become the “buyer of last resort” for all sorts of financial assets.
However, while it is giving the banks this sort of general support, it hopes to isolate specific bust banks and force them to either raise money or burn their bondholders.
This new policy is obviously precisely the opposite of the ECB intervention in Ireland.
Therefore, late on Friday the ECB refused the Italian government’s attempt to buy more time to find money for its stricken bank Monte dei Paschi di Siena. This bank is likely to be bailed out by the state this weekend, but with significant losses imposed on the bondholders, who are largely local Italian people whose pension funds bought bank bonds.
But for Italy the issue is not whether it can, in the short term, manage liquidity problems in its banks; the really big issue is whether the Italian state itself is solvent.
By joining the euro and abandoning the tool of regular devaluations on the altar of European integration, Italy has imperilled itself. It is profoundly uncompetitive. When a country becomes uncompetitive, it eventually becomes insolvent because it has no way of paying its debts.
It is very clear, when you look at the numbers that Italy will become insolvent at some stage. In the euro, its trajectory versus Germany is now more or less fixed. The 50-year, post-war policy of devaluations helping Italian industry and keeping up with Germany is now over.
Italy is now lagging far behind and it is falling further adrift.
This is a big deal for Europe and the euro. Italy is not Greece.
When this event happens no one can be sure, but that it will happen is, at this stage, beyond doubt.
Maybe for watchers of Europe, the real question is not when Britain leaves the EU, but whether Italy goes bust before Britain goes off.
What odds would you give on that?