It Was Never Destined to Work …
The markets have given Italy's debt the benefit of the doubt based on the ECB's OMT promise, but the basic problem still awaits resolution. In the past, Italy would have simply devalued the lira, confiscating its citizenry's vast savings with the hidden inflation tax and devaluing the government's outstanding debt. This time it had to implement 'reform', but the man chosen to do that was a typical EU approved bureaucrat, someone who knows absolutely nothing about the daily struggle producers of wealth face in the marketplace. And so Mr. Monti did what a statist bureaucrat is wont to do: he raised a plethora of taxes, severely restricted the use of cash and ordered the tax bureau to go on a hugely repressive hunt for all sorts of perceived tax cheats, down to the pensioners who help with olive tree maintenance to supplement their meager incomes in order not to starve. The openly declared goal of these activities was to intimidate the citizenry. We're not just making this up – this is what they said they wanted to achieve, even if their actions were to weigh on the economy. We have detailed some of the methods employed in a past write-up.
As Italy's tax payer association remarked last year: “Monti's reform has consisted of introducing new taxes and nothing else”.
Not surprisingly, the underlying problems therefore remain firmly in place. The government's outstanding stock of debt has continued to rise (at a rate of almost €75 billion per year), the economy has tanked and the citizenry has been terrorized. Good job.
Now the bond market's equanimity can apparently no longer be counted on, although this is of course currently not a matter confined to Italy – bond yields have been surging worldwide. The problem for Italy is that if bond yields continue to rise, unstoppable debt spiral dynamics will reassert themselves. Moreover, the banking system will be in even bigger trouble than it already is, as the banks are up to their eyebrows in Italian government bonds.
Solvency Risk on Yellow Alert
Mediobanca has constructed a 'solvency risk' indicator that is lately giving alarm signals. This is an ominous development, especially as the governing coalition is under strain. According to a recent Telegraph report, Italy may require a rescue within six months unless a miracle happens. It looks like Super-Mario's OMT promises will be tested after all:
“Mediobanca, Italy’s second biggest bank, said its “index of solvency risk” for Italy was already flashing warning signs as the worldwide bond rout continued into a second week, pushing up borrowing costs.
“Time is running out fast,” said Mediobanca’s top analyst, Antonio Guglielmi, in a confidential client note. “The Italian macro situation has not improved over the last quarter, rather the contrary. Some 160 large corporates in Italy are now in special crisis administration.”
The report warned that Italy will “inevitably end up in an EU bail-out request” over the next six months, unless it can count on low borrowing costs and a broader recovery.
Emphasising the gravity of the situation, it compared the crisis with when the country was blown out of the Exchange Rate Mechanism in 1992 despite drastic austerity measures. Italy’s €2.1 trillion (£1.8 trillion) debt is the world’s third largest after the US and Japan. Any serious stress in its debt markets threatens to reignite the eurozone crisis. This may already have begun after the US Federal Reserve signaled last week that it will begin to drain dollar liquidity from the global system.”
Sovereign debt strategist Nicolas Spiro said “taper terror” is jolting eurozone investors out of their complacency, though safe-haven Swiss and German bonds have also sold off sharply in the rout. Yields on 10-year UK Gilts closed at a two-year high of 2.53pc.
Yields punched to 5.1pc in Spain, and 6.7pc in Portugal. This is sending a secondary shock wave through their corporate debt markets, choking recovery.
“The European Central Bank needs to take very aggressive steps to offset this,” said Marchel Alexandrovich from Jefferies Fixed Income. “We have a sell-off across the board. If the ECB doesn’t act, it could see all the gains of the past nine months vanish in two weeks, taking the eurozone back to square one.”
Borrowing costs of 5pc could prove crippling for Spain and Italy, both suffering from contraction of nominal GDP.
Mediobanca said the trigger for a blow-up in Italy could be a bail-out crisis for Slovenia or an ugly turn of events in Argentina, which has close links to Italian business. “Argentina in particular worries us, as a new default seems likely.”
So the cries for more central bank intervention are already going up – no surprise there. We found the tidbit about Argentina potentially becoming a trigger for a crisis in Italy interesting – we were unaware of the strong economic ties mentioned by Mediobanca.
Shady Derivatives Deals Helped to Hide Debt
In the meantime it has also turned out that just like Greece, Italy used complex derivatives deals to lie about the size of its debt prior to its accession to the euro (readers may recall that we have mentioned in the past that all governments lied about their debt in some shape or form at the time – now it is finally officially admitted, bit by bit). While this has a surprise coefficient of exactly zero, the admission means that there will likely be an immediate hit to the budget, euro. And guess who was one of the Italian officials deeply involved at the time with the country's debt and deficit accounting? The man who presumably helped with cooking up this scheme? It was none other a certain rather well-known Goldman Sachs alumnus who currently runs the ECB (this was shortly before he joined GS by the way).
“Italy risks potential losses of billions of euros on derivatives contracts it restructured at the height of the euro zone crisis, according to a confidential report by the Rome Treasury that sheds more light on the financial tactics that enabled the debt-laden country to enter the euro in 1999.
A 29-page report by the Treasury, obtained by the Financial Times, details Italy's debt transactions and exposure in the first half of 2012, including the restructuring of eight derivatives contracts with foreign banks with a total notional value of €31.7 billion.
While the report leaves out crucial details and appears intended not to give a full picture of Italy's potential losses, experts who examined it told the Financial Times the restructuring allowed the cash-strapped Treasury to stagger payments owed to foreign banks over a longer period but, in some cases, at more disadvantageous terms for Italy.
The report does not name the banks or give details of the original contracts – questions that worried the state auditors – but the experts said they appeared to date back to the period in the late 1990s. At that time, before and just after Italy entered the euro, Rome was flattering its accounts by taking upfront payments from banks in order to meet the deficit targets set by the EU for joining the first wave of 11 countries that adopted the euro in 1999.
Italy had a budget deficit of 7.7 percent in 1995. By 1998, the crucial year for approval of its euro membership, this had been reduced to 2.7 percent, by far the largest drop among the Euro 11.”
Mario Draghi, now head of the European Central Bank, was director-general of the Italian Treasury at the time, working with Vincenzo La Via, then head of the debt department, and Ms Cannata, then a senior official involved with debt and deficit accounting.”
It is quite ironic that Mario Draghi may now well end up as the person imposing 'conditionality' (read: severe austerity measures) on Italy when its government finally comes to the ECB, hat in hand. As an aside, the € 8 billion figure is an estimate, as Italy of course does not fully disclose the extent of its derivatives losses. The ECB is rather tight-lipped about the involvement of its boss as well:
“An ECB spokesman declined to comment on the bank's knowledge of Italy's potential exposure to derivatives losses or on Mr Draghi's role in approving derivatives contracts in the 1990s before he joined Goldman Sachs International in 2002.”
Again, surprise factor zero. Very likely it will all be swept under the rug. The main thing is to keep the Italian population properly terrorized after all, not going after those who are actually responsible for the mess the country is in.
Lastly, there has been a surprising spike in successful prosecutions of former prime minister Berlusconi in the meantime. He was just convicted for the third time in a row, this time of allegedly 'paying a minor for sex'.
Berlusconi himself of course maintains that what is going on is a political witch hunt. It is probably true that he has done all sorts of legally dubious things in the course of his career – how else would he ever have become prime minister of Italy as well as a billionaire media mogul in a high tax regulatory democracy? No-one who actually hews 100% to the rules and regulations of the modern-day 'free' economic tyrannies can ever hope to accumulate such a huge amount of capital. However, that means that Berlusconi is probably no worse than others in similar positions. In that sense he is probably correct: if not for the fact that powerful forces within the EU want to get rid of him, he simply wouldn't be successfully prosecuted. Note that Berlusconi wants to roll back the worst excesses of Monti's so-called 'reforms'. He is therefore seen as a danger to the EU centralization project – a thorn in the side of the socialist super-state. Here are two brief quotes from the Bloomberg article on the conviction:
“The verdict “confirms the intention to eliminate Prime Minister Berlusconi from the political scene,” Paolo Bonaiuti, a senator and spokesman for Berlusconi, said in an e-mailed statement.
Berlusconi’s trials may pose a greater threat to his political career than to his freedom, given Italy’s flexible sentencing and indulgence toward convicts over the age of 70.”
Regardless though of the motives and the question of Berlusconi's guilt or innocence, the immediate effect will be that the coalition government will find it harder to introduce new reform measures. Prime minister Letta's latest plans require the support of Berlusconi's party. As one observer remarked:
“Letta’s going to have to fight very hard to keep his boat on course,” said James Walston, a professor at the American University in Rome. The verdict “makes the Berlusconi supporters all the more hyped up and angry, and they’re going to be a lot tougher on completely irrelevant issues.”
One bone of contention is Letta's plan to increase VAT, which Berlusconi opposes. It is conceivable, although most observers don't think it is likely at the moment, that the coalition will split up again. In that case, new elections will have to be held.
Meanwhile, the Milan Stock Index (MIB) looks quite wobbly as well of late:
Italy may soon be making its way back to page 1 from page 16. It remains the euro area's most worrisome problem, given the huge size of its outstanding debt (Italy's government debt stock is the third largest in the world). A renewed flaring up of the crisis with a focus on Italy is the eurocracy's worst nightmare. It is a good bet that if it happens, it will happen at an extremely inopportune moment. Right now everybody is hoping and praying that nothing untoward occurs prior to Germany's election – but no-one knows if the markets will comply with such wishes. If the recent massacre in international bond markets continues, there will be nothing that can be done to keep the Italian debt problem from resurfacing with a vengeance.
Charts by: BigCharts
You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.
Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke
2 Responses to “Clouds Gather Over Italy”
Most read in the last 20 days:
- Gold Sector: Positioning and Sentiment
A Case of Botched Timing, But... When last we wrote about the gold sector in mid February, we discussed historical patterns in the HUI following breaches of its 200-day moving average from below. Given that we expected such a breach to occur relatively soon, the post turned out to be rather ill-timed. Luckily we always advise readers that we are not exactly Nostradamus (occasionally our timing is a bit better). Below is a chart of the HUI Index depicting the action since the January...
- India: The next Pakistan?
India’s Rapid Degradation This is Part XI of a series of articles (the most recent of which is linked here) in which I have provided regular updates on what started as the demonetization of 86% of India's currency. The story of demonetization and the ensuing developments were merely a vehicle for me to explore Indian institutions, culture and society. The Modimobile is making the rounds amid a flower shower. [PT] Photo credit: PTI Photo Tribal cultures face...
- The Long Run Economics of Debt Based Stimulus
Onward vs. Upward Something both unwanted and unexpected has tormented western economies in the 21st century. Gross domestic product (GDP) has moderated onward while government debt has spiked upward. Orthodox economists continue to be flummoxed by what has transpired. What happened to the miracle? The Keynesian wet dream of an unfettered fiat debt money system has been realized, and debt has been duly expanded at every opportunity. Although the fat lady has so far only...
- March to Default
Style Over Substance “May you live in interesting times,” says the ancient Chinese curse. No doubt about it, we live in interesting times. Hardly a day goes by that we’re not aghast and astounded by a series of grotesque caricatures of the world as at devolves towards vulgarity. Just this week, for instance, U.S. Representative Maxine Waters tweeted, “Get ready for impeachment.” Well, Maxine Waters is obviously right – impeaching the president is an urgent...
- Welcome to Totalitarian America, President Trump!
Trump vs. the Deep State If there had been any doubt that the land of the free and home of the brave is now a totalitarian society, the revelations that its Chief Executive Officer has been spied upon while campaigning for that office and during his brief tenure as president should now be allayed. Image adapted from the cover of “Deep State #5” - depicting an assassin from the future President Trump joins the very crowded list of opponents of the American...
- Searching for Truth
Heresy or Truth? RANCHO SANTANA, NICARAGUA – In the fifth century, Christian scholars counted 88 different heresies. Arianism. Eutychianism. Nestorianism. If there was a way to “offend” God, they had a name for it. One group of “heretics” argued that there was no such thing as “original sin.” Another denied the trinity. And another claimed Jesus was not divine. Which one had the truth? Depiction of the first Council of Ephesus in 431 AD, convened by Emperor...
- Why the 21st Century Sucks - Turtles All the Way Down
A Truly Sucky Century BALTIMORE – What an awful century! Worst we’ve ever seen. Household incomes are down. Employment is down, with 7 million people in the U.S. of working age without jobs. Productivity growth is down. GDP growth is down – to only about 0.5% per capita last year. Even life expectancies are down. Drug overdoses are up. Suicides are up. One out of every eight children lives in a family getting food stamps. One of out every eight adults takes psychoactive drugs...
- Gold and the Fed's Looming Rate Hike in March
Long Term Technical Backdrop Constructive After a challenging Q4 in 2016 in the context of rising bond yields and a stronger US dollar, gold seems to be getting its shine back in Q1. The technical picture is beginning to look a little more constructive and the “reflation trade”, spurred on further by expectations of higher infrastructure spending and tax cuts in the US, has thus far also benefited gold. From a technical perspective, there are indications that the low at $1045.40,...
- The Unstable Empire – A Campfire Tale
Campfire Tale Caesar: The Ides of March are come. Soothsayer: Ay, Caesar, but not gone. — Julius Caesar, Shakespeare GRANADA, NICARAGUA – Today, we stop the horses and circle the wagons. For 19 years, we have been rolling along, exploring, discovering. We began with the assumption that we didn’t “know” anything - so we kept our eyes open. Now we know even less. Famous people who knew nothing and were not shy to admit it: Sergeant Schultz...
- Off the Beaten Path in Mesoamerica
Greeted by Rooster There’s an endearing quality to a steadfast rooster call at the crack of dawn when overheard from a warm country farmhouse. There’s a reassuring charm that comes with the committed gallinaceous greeting of daybreak that’s particularly suited to a rural ambiance. The allure of a morning cock-a-doodle-doo somehow falls flat in all other settings. Good morning everyone! Before meteorological forecasts were available on TV and smart phones, people...
- Why Silver Went Down – Precious Metals Supply and Demand
Rumor-Mongering vs. Data The question on the lips of everyone who plans to exchange his metal for dollars—widely thought to be money—is why did silver go down? The price of silver in dollar terms dropped from about 18 bucks to about 17, or about 5 percent. Reportedly silver was already assassinated in the late 19th century... so last week they must have assassinated its corpse. [PT] Illustration taken from 'Coin's Financial School' The facile answer is...
- Systematic Trading - Unwrapping the Onion
Lumpy but Robust [ed note: this article has originally appeared at the Evil Speculator and was written by trader and ES contributor Scott. We provide a link to Scott's past articles below this post for readers who want to get more familiar with his ideas and/or any unusual terminology used in this article] One continual theme in my trading is that every time I think I have it figured out, I get punched in the face by an unexpected problem. The tendency is to go more...