What a lot of news lately - I was thinking recently that it's almost like watching a soap opera gone badly astray from the original plot! So in this posting I want to pull together some thoughts on the European situation.
I am doing this because I am frankly tired of reading some of the "doom and gloom" commentaries that other (mostly "glitterati") economists are producing. Roubini's comments (see here) on Italy potentially leaving the euro area were simply over the top and illustrate that some economists simply don't understand the European project (despite the fact that Roubini is from Italy) or appreciate optimal currency area theory. And Roubini wasn't alone - just read Krugman's (here), Martin Wolf (here) and even George Soros (here). This alarmist reaction to what is going on in Europe is not only unhelpful but (as noted by one response to Roubini's commentary) it is alarmist and almost hysterical. Let's not forget that Italy has a very high savings rate compared to many countries and given the economic downturn their savings rate is likely higher than where it was back in 2009 when it stood at 14% of GDP. So the run up in Italian bond yields is not something to worry about, and this was amply illustrated when the market realized this and quickly shifted it's attention over to Spain when the latest auction of Italian bonds was successful. Italy is definitely not Greece, and Italy's debt, as I recall, was 112% of GDP when they joined the euro area back in 1999, so why should there suddenly be a "crisis" when Italy's debt to GDP ratio is now 118%?
Here are the national savings rates for various countries as of 2007:
Economics also backs this up, in the form of analysis of savings and investment, along with the funding of public sector debt. Countries that have high domestic savings rates (like Japan, for example), have no trouble funding extremely large public (and private) debts. Countries like the US with relatively low savings rates have much more reliance on external funding of their public debt, and therefore the international bond markets. Obviously the higher the debt and the lower the national savings rate (as well as other factors such as whether the country has defaulted before, as pointed out by Rheinhart and Rogoff), the more likely it is that difficulties will occur in funding debt. So where does this put Italy? Italy's savings rate is one of the highest in Europe, and although it has been falling, it is still a sizeable chunk of GDP, so that it is unlikely that the Italian government would ever default. Add to that the fact that Burlesconi is gone and has been replaced by a "technocrat" economist (Mario Monti) who was previously an EU Commissioner, with Monti having a cabinet of no less than 7 professors, and the fact that the new ECB President is an Italian (Mario Draghi) and I think you have the recipe for losing a lot of money in the bond markets if you take a bet that interests rates on Italian bonds will stay high. Indeed, as I didn't manage to get this post up before leaving the US for Africa I have managed to get an overnight 15% return on my bet on Italian bond yields coming down by using the ETN ITLT.
But the main message I want to get across on Europe is that the euro is NOT going away anytime soon, as some commentators seem to think. Although member states should be free to, or forced to leave, Germany, France, Austria, Italy, the Netherlands, Belgium, Luxembourg and Finland do not seem to be pulling apart economically speaking, and if push comes to shove the ECB is not going to allow bond "vigilantes" to threaten its very existence. Collapse, in my opinion, is unimaginable in the current circumstances - but crisis and default are not. The Economist's commentary on Germany's rigidity (here) in seeking solutions to the euro area's problems was instructive but failed to point out that Germany has benefitted from the euro as if it had continued to adopt the Deutschmark it's exchange rate would likely have been higher than current levels of the euro and so their economy has been given a boost through their export sector.
Next post will deal with the perhaps more severe problem of the banking liquidity issue in Europe.
I am doing this because I am frankly tired of reading some of the "doom and gloom" commentaries that other (mostly "glitterati") economists are producing. Roubini's comments (see here) on Italy potentially leaving the euro area were simply over the top and illustrate that some economists simply don't understand the European project (despite the fact that Roubini is from Italy) or appreciate optimal currency area theory. And Roubini wasn't alone - just read Krugman's (here), Martin Wolf (here) and even George Soros (here). This alarmist reaction to what is going on in Europe is not only unhelpful but (as noted by one response to Roubini's commentary) it is alarmist and almost hysterical. Let's not forget that Italy has a very high savings rate compared to many countries and given the economic downturn their savings rate is likely higher than where it was back in 2009 when it stood at 14% of GDP. So the run up in Italian bond yields is not something to worry about, and this was amply illustrated when the market realized this and quickly shifted it's attention over to Spain when the latest auction of Italian bonds was successful. Italy is definitely not Greece, and Italy's debt, as I recall, was 112% of GDP when they joined the euro area back in 1999, so why should there suddenly be a "crisis" when Italy's debt to GDP ratio is now 118%?
Here are the national savings rates for various countries as of 2007:
But the main message I want to get across on Europe is that the euro is NOT going away anytime soon, as some commentators seem to think. Although member states should be free to, or forced to leave, Germany, France, Austria, Italy, the Netherlands, Belgium, Luxembourg and Finland do not seem to be pulling apart economically speaking, and if push comes to shove the ECB is not going to allow bond "vigilantes" to threaten its very existence. Collapse, in my opinion, is unimaginable in the current circumstances - but crisis and default are not. The Economist's commentary on Germany's rigidity (here) in seeking solutions to the euro area's problems was instructive but failed to point out that Germany has benefitted from the euro as if it had continued to adopt the Deutschmark it's exchange rate would likely have been higher than current levels of the euro and so their economy has been given a boost through their export sector.
Next post will deal with the perhaps more severe problem of the banking liquidity issue in Europe.
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