A Tale of Two Faux Crises: Italy, Spain and the Euro

Money and Development Seminar Series

29 February 2012

John WeeksProfessor Emeritus, SOAShttp://jweeks.org

Background:Two non-technical articles:

"Democracy in Europe and the Italian Crisis"In Insight

http://www.insightweb.it/web/

"Catastrophe Now: The Euro Runs its Course"In the Social Europe Journal

http://www.social-europe.eu/

Both linked on http://jweeks.org

Statistical Sources:

1. OECDwww.oecd.org (click on "statistics")

2. Eurostathttp://epp.eurostat.ec.europe.eu/portal/

Especially Supplementary Tables on the Financial Crisis

Definitions1. Debt: gross and netOECD definition of the net debt is liabilities minus liquid assets. Examples: In 2011, Norway's gross debt was just below the

infamous Maastricht criterion at 56% of GDP. Its net debt was minus 160 percent of GDP. For the UK the numbers were 90% and 64%.

2. DeficitsTotal fiscal balance is revenues minus expenditures. The primary

balance is net of interest, which the IMF uses for its test of fiscal stability.

For no obvious reason, the Maastricht criteria refer to the gross debt and total fiscal balance.

Simple algebra of deficits:

Define:

B = fiscal balance = revenue - expenditure

B* = primary fiscal balance

= revenue - non-interest expenditure

= zY - (Ē - eY)

z is the tax rate (average = marginal)

Y is national income

Ē is discretionary expenditure

e is automatic counter-cyclical expenditure

B* = Y - [Ē - eY]

B* = [zY + Yz] - [eY - Ye]

d' = B/Y = [z + e]g

If z = e = 0

g = Y/Y, GDP growth rate,

d' = first difference of the primary fiscal deficit,

The Italian Story:High borrowing rates in the 1990s

and

German trade policy in the 2000s

Yield on long term public bonds andinterest payments as share of GDP, 1993-2011[Interest rates now lower than for 1993-2002]

0

2

4

6

8

10

12

14

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

interest on debt(% of GDP)

Long termyield on public bonds(% )

Italy: Total and primary deficits, 1993-2011[Lowest primary deficit in the euro zoneand recent decline recession-generated]

-10

-8

-6

-4

-2

0

2

4

6

8

10

12

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Intereston debt

Overalldeficit

Primarydeficit

Globalrecession

Italy: Changes in the public sector balance has been GDP driven,1993-2011 (share of GDP)

-6.0

-4.0

-2.0

.0

2.0

4.0

6.0

-4.0 -2.0 0.0 2.0 4.0

Change in PrimaryDeficit

GD

P G

row

th

ln[FsDf/GDP] = -.01 + .47ln[GDP grw]F = 9.9 (R2 = .38), DF = 16

Italy: The public debt "burden" has declined, 1993-2011[real value of net debt in 2011 same as 1997]

0

500

1000

1500

2000

2500

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

0

50

100

150

200

250Public debtprices of 2011bns of euros

gross

net

Debt burden 2011 prices,interest rate adjusted

bns of euros

gross

net

2047 bn

1597 bn

Fiscal balance in surplus, net debt steady,what is the problem?[Not real wage inflation as suggested by Krugman]

-4

-2

0

2

4

6

8

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

`

Ratio of Italian to German private sector real wages1994-2009

German trade policy is the problem:Italian-German trade balance & unit labour costs, 1994-2009

[Falling German unit costs result of relatively faster productivity increases and export subsidies]

-25

-20

-15

-10

-5

0

5

10

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

-30

-25

-20

-15

-10

-5

0

5

10 ULC Germany/Italy, 1998=0

Trade balance Italy-Germany, € bns

`

Inflexible labour market in Italy?Not according to the OECD

-30

-25

-20

-15

-10

-5

0

5

10

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

.0

.2

.4

.6

.8

1.0

1.2

1.4

1.6

Italy's trade balancewith Germany

OECD employmentprotection index,Italy/Germany

The Italian story summarizedItaly has not had does not have an excessive fiscal deficit. On the contrary, for the last twenty years it has had the best primary fiscal balance in the European Union. In the 1990s it suffered from unwise borrowing at high interest rates. That problem is over. Present "unsustainable" interest rates are well below the level of the 1990s.

Italy's public debt is no larger in real terms than it was twenty years ago. Its interest-adjusted "burden" is far lower.

Italy has a serious trade deficit with Germany, that results in great part from implicit and explicit export subsidies. The most important of these are:

1) suppression of domestic demand

2) VAT and pay roll tax relief on export commodities

The Spanish Story:

No good deed

goes unpunished.

Fiscal surpluses in Spain, 1993-2011

-12.0

-10.0

-8.0

-6.0

-4.0

-2.0

.0

2.0

4.0

6.0

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Total Deficit/GDP

Primary Deficit/GDP

Even in Spain recession causes deficitsGDP and the total deficit, 1993-2011

-50

-40

-30

-20

-10

0

10

20

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

-13.0

-11.0

-9.0

-7.0

-5.0

-3.0

-1.0

1.0

3.0

GDP (2004 = 0)

Total Deficit

And growth reduces the deficitSpain: GDP growth and the first difference in the primary balance, 1993-2011

-5.0

-4.0

-3.0

-2.0

-1.0

.0

1.0

2.0

3.0

4.0

5.0

-7.0 -5.0 -3.0 -1.0 1.0 3.0

Change in primary Deficit/GDP

GD

P G

row

th

ln[FsDf/GDP] = -.02 + .68ln[GDP grw]F = 8.1 (R2 = .35), DF = 15

Spain & the euro

During 1990-2007 property speculation resulted in an asset bubble in Spain as or more extreme than in North America. The speculation included large exposures of Spanish banks in the US sub-prime market.

When the bubble burst, the Spanish government embarked on a bank recapitalization ("bailout") that generated an annual average primary deficit of minus 7% of GDP.

In the absence of the bailout the primary fiscal balance was minus 2% of GDP.

Spain: Public sector balance, 2001-2010

-12.0

-10.0

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Total deficit/GDP

Less bank bailout

The Spanish story summarized:[technical term is "chutzpah"]

To save the financial sector from collapse, the Spanish government [social democrat!] bailed it out. The bailout more than tripled the fiscal deficit. The rescued Spanish financial institutions used the bailout funds to speculate on government bonds, thus creating the fiction that public finances were unsustainable.

What to do in the euro zone

Comment on Krugman & devaluation

German expansion

Deficit country export subsidies

The Great Euro Scam

Along side the Tulip Mania of the 1630s, the South Sea Bubble (1720s) and other ponzi schemes will go the Great Euro Scam of the 2000s, characterized by both tragedy and farce.

The farce: Central Bank of Europe leaning to banks at 2-3%, so the banks could buy Greek, Italian, Portuguese and Spanish bonds paying 7-15%.

The tragedy: The political purpose of the "crisis", the end of social democracy and weakening of representative government, is succeeding.