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Greece, Italy and the Euro

by Ivan Seeking
Tags: euro, greece, italy
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Nikitin
#55
Nov10-11, 09:48 AM
P: 627
I don't know, really, I am not a financial expert. But it seems to me that CDSs, which are 'bets' in the hands of others than the government, are indifferent to Italy's government debt position. The market is weird, the CDSs predicted a 100% certain Greek collapse which didn't happen yet. I am pretty certain the CDS rates, whatever they are at the moment, are not a good predictor since I imagine most people will expect Europe to take over the debt; i.e., the debt is mostly guaranteed, but the Italian government will not be able to borrow from the financial markets itself but will need to go through the IMF/EFSF. At worst, they are a market predictor of the whole of Europe going bankrupt.
No, the CDS predicted that Greece would default on its loans {again}. The prediction was right, as Greek debt was haircut (not a technical default as that would be catastrophic, but a default none the less).
Borg
#56
Nov10-11, 10:11 AM
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Quote Quote by Nikitin View Post
I don't know much about the federal government's involvement, though I seriously doubt its involvement was destructive, but I'm pretty sure the stock market crash was not merely a symptom. Loads of people were loaning money from the banks and putting the money into the stock market. When the stock market crashed, lots of people were without money to repay the banks.
Yup. Though if you're buying 10-year bonds It'd be silly to worry about Berlusconi being booted and some financial problems. Chances are Italy will get into much bigger trouble than this during a 10 year period, thus the yield increase isn't really rational.
I didn't say anything about Berlusconi or that this has anything to do with him. You're not making sense w.r.t. the bonds. If Italy defaults, the 10 year bonds will be worth zero. That is clearly something for the markets to worry about.
Nikitin
#57
Nov10-11, 11:36 AM
P: 627
This has everything to do with Berlusconi. The yield jumped from a sustainable rate to 7,4% directly due to the political squabbling and Berlusconi's removal.

Italy will not default due to some political instability. Italy will default if its debt gets out of control and economy start to break down.

My point was, that it is highly improbable that Italy won't get into worse trouble than it is in today. The yield of 10 year bonds shouldn't really be affected much by current events, but by the structural health of the Italian economy (which isn't nearly as bad as Greece's or Protgual's).
MarcoD
#58
Nov10-11, 12:11 PM
P: 98
Quote Quote by Nikitin View Post
No, the CDS predicted that Greece would default on its loans {again}. The prediction was right, as Greek debt was haircut (not a technical default as that would be catastrophic, but a default none the less).
I agree, I stand corrected. The market predicted a haircut and it happened in the Greek case. I saw that the Italian CDSs became somewhat more expensive but I can't translate it to a probability on an Italian default. I think I heard it being translated to around 50% on the radio, but I might have gotten it wrong.

I am a bit baffled by people proposing that the ECB should buy the Italian debt though. I mean, that's equivalent to just printing money to buy debt, right? Looks to me that they can do that a little bit, but at the risk of (hyper-)inflation, pushing up the interest rates of all European economies, and subsequently blowing up the whole of Europe. I mean, Dutch interest rates are 2.2% now, what happens if all European governments need to borrow at 7%?
mheslep
#59
Nov10-11, 12:26 PM
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Greece, Italy and the Euro Thread:

Quote Quote by Nikitin View Post
I don't know much about the federal government's involvement, though I seriously doubt its involvement was destructive, ...
There had been several similar panics prior to 1929; in those instances the market and economy always recovered within a year or so. The 1907 panic caused a 50% stock drop which returned to previous highs within eight months. In the months after the 1929 panic the stock market recovered half its value before the government via the actions of the Federal Reserve turned the panic into a national banking collapse which began the Great Depression. There is debate about the impact of policy actions by the US government itself (i.e. not the central bank) with regards to extending or shortening the Depression, but there is no question that at least some of those actions were destructive; NIRA in particular was found unconstitutional and was cancelled.

Quote Quote by Ben Bernanke, now Fed Chairman, in 2002
"Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again.
http://en.wikipedia.org/wiki/Causes_...eat_Depression
John Creighto
#60
Nov10-11, 01:48 PM
P: 813
Quote Quote by MarcoD View Post
I agree, I stand corrected. The market predicted a haircut and it happened in the Greek case. I saw that the Italian CDSs became somewhat more expensive but I can't translate it to a probability on an Italian default. I think I heard it being translated to around 50% on the radio, but I might have gotten it wrong.

I am a bit baffled by people proposing that the ECB should buy the Italian debt though. I mean, that's equivalent to just printing money to buy debt, right? Looks to me that they can do that a little bit, but at the risk of (hyper-)inflation, pushing up the interest rates of all European economies, and subsequently blowing up the whole of Europe. I mean, Dutch interest rates are 2.2% now, what happens if all European governments need to borrow at 7%?
If all of the European governments needed to borrow at 7% then certainly the Dutch interest rate wouldn’t be 2.2%. If the European central banks were trying to not change the money supply they could sell their Dutch debt and buy Italian debt. All central banks influences the money supply by their actions. The only question is how should they do it and how much should they do it.
klimatos
#61
Nov10-11, 03:30 PM
P: 412
Quote Quote by mheslep View Post
Perhaps, but how do you know this? For all I know Greek bonds are held by the Wisconsin teachers union pension fund, and they, or those like them, are exerting political influence on the IMF level pullers.
I have a daughter who is very high in international banking circles. She predicted every step of the Lehman Brothers fiasco months in advance and warned the Bank of England that they were about to be ripped off. The Bank's response was, "No, No, No. The US wouldn't do that to us!" Now, they know better.

By the way, she predicts that Bank of America will be in Chapter 11 within six months.
MarcoD
#62
Nov10-11, 05:40 PM
P: 98
Quote Quote by John Creighto View Post
If all of the European governments needed to borrow at 7% then certainly the Dutch interest rate wouldn’t be 2.2%. If the European central banks were trying to not change the money supply they could sell their Dutch debt and buy Italian debt. All central banks influences the money supply by their actions. The only question is how should they do it and how much should they do it.
Yah, that was my point, that with too much inflation all the European governments would need to pay too much interest and in the end the European economy would blow up.

Somehow, given the lack of interest of the ECB and other affiliated central banks, I have the feeling that they are laughing their heads off.

(I checked the assets of the Dutch Central Bank, which is a member on the council of the ECB. I doubt the assets of all the European central banks combined are enough to fill the Italian debt hole, so the ECB can only buy debt with freshly 'printed' money, or European banks chip in. That's the silly thing: I doubt there even would be a debt problem if all the European banks agree to buy the debt. But that's similar like giving a blank cheque to government... seems like a lousy idea to me.)
DoggerDan
#63
Nov11-11, 02:56 AM
P: 77
Quote Quote by mheslep View Post
The 1907 panic caused a 50% stock drop which returned to previous highs within eight months.
Precisely. No matter how bad things get, life moves on. Sometimes sooner, sometimes later.

Still, we persist.
John Creighto
#64
Nov13-11, 12:02 AM
P: 813
I think the facts are something like this (I need to confirm this with sources). I think the interest rates quoted are for loans with two year terms. For Italy 7% is considered dangerous. 5% is considered stable. Markets valued Greek debt at 50% before the haircut. The actually haircut I think was effectively 20%. That's about a 10% loss per year. If both the risk free rate of return was 2% (which is the target inflation rate) and a 20% haircut was considered likely then one might expect a fair market value for the interest rate on Italian debt to be around 12%.


The fact that interest rates are only 7% could mean the markets think one of the following:
1)the risk of an Itialian debt haircut isn't significant
2)the governments will cover the risk of Italian debt
3)their will be about 5% deflation per year.

For point 1, the Italian economy is considered in much better shape then Greece. For point 2. There has been some precedent of Europe helping to guarantee sovereign debt. Additional the ECB has been buying some sovereign debt to help reduce pressure on the interest rates.

With regards to point three while a 5% deflation rate is not likely to be seen in the CPI, asset prices have fallen significantly since the downturn. Stock market valuations (adjusted for inflation) have not fallen to the lows of the 80s and as the baby-boomers start to draw down their retirement assets there will be further downward pressure on asset valuations.

http://modeledbehavior.com/2011/02/22/the-401k-pyramid/
MarcoD
#65
Nov13-11, 08:41 AM
P: 98
Quote Quote by John Creighto View Post
I think the facts are something like this.
I think all the facts can be derived from the following table:



The 'red' countries are in problems, Germany and France pretend that they are trying to fix things, which can't be true since their debt cannot run higher. Moreover, Europe can be damned glad with the former eastern bloc countries, who have low debt and a lot of room for growth.

Greece was never a problem (in the sense that I imagine the rest of the EU is more worried about their own debt), Spain cannot possibly be a problem, it is Italy and worst case France and Germany themselves which are the problem.
MarcoD
#66
Nov13-11, 10:18 AM
P: 98
Quote Quote by John Creighto View Post
The fact that interest rates are only 7% could mean the markets think one of the following:
1)the risk of an Itialian debt haircut isn't significant
2)the governments will cover the risk of Italian debt
3)their will be about 5% deflation per year.
1) It may happen, but it is unlikely, Italy can even sustain 7% several years. 2) Can't really happen, they can take over some of the debt, but not all. 3) I think you mean inflation? My guess is that inflation is probably the worst which can happen; it will deflate the debt burden a bit, but at the cost of increasing the interest rates when rolling over the debt and evaporating Northern European investments.

If you look at the European figures of the previous post, the problem just isn't that big at the moment to start the money printing presses - and some of the Northern European countries will be very upset if the ECB starts doing that; I doubt it will happen. It is mostly sentiment which says that Europe is in a bad shape which, unfortunately, is also a hard economic fact.

The problem is the Italian government. They have been unable, under Berlusconi, to implement market reforms and austerity measures to get the Italian debt lower. In fact, they have seemed to have done the opposite the last decade. Now they have to, but it may be too little, too late, for market sentiment.
AlephZero
#67
Nov13-11, 10:44 AM
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Quote Quote by MarcoD View Post
1) It may happen, but it is unlikely, Italy can even sustain 7% several years.
That is very unlikely under any set of assumptions. The only way to sustain debt in the long term is for the economy to grow faster than the debt interest rate, (and allowing for inflation). The Eurozone strategy on inflation is to keep it low (say less than 3%). The long term growth rate of the Italian economy has been less than 1%. So the debt is sustainable if 3+1 > 7. Financial engineers spend their working lives redefining the rules of arithmetic, but that's a tough one even for them to justify.
MarcoD
#68
Nov13-11, 10:52 AM
P: 98
Quote Quote by AlephZero View Post
That is very unlikely under any set of assumptions. The only way to sustain debt in the long term is for the economy to grow faster than the debt interest rate, (and allowing for inflation). The Eurozone strategy on inflation is to keep it low (say less than 3%). The long term growth rate of the Italian economy has been less than 1%. So the debt is sustainable if 3+1 > 7. Financial engineers spend their working lives redefining the rules of arithmetic, but that's a tough one even for them to justify.
I agree with that, the debt would grow under these circumstances. But it can grow to, say, a 140% GDP before the government would go bankrupt. It ain't nice, but they could do that for a few years, if they would find a way out meantime.

[ The thing with Italy is that they have the money, they just don't tax enough. ]

[ Of course, I am Dutch. My best guess is that a combination of austerity in Italy and not starting the money presses is the best for the Netherlands, and probably most of the Scandinavian countries. The French, Germans, and Brits may disagree, though, not sure. ]
John Creighto
#69
Nov13-11, 11:52 AM
P: 813
Quote Quote by MarcoD View Post
I think all the facts can be derived from the following table:



The 'red' countries are in problems,
Maybe but who decided that above 90% debt to GDP was a dangerous situation. I read somewhere else that 120% debt to GDP was sustainable. Japan was even able to sustain a higher debt to GDP then Greece but Japan has control over it's currency. What debt levels are sustainable is partly driven by Germany's fear of inflation
http://www.americanfuture.net/2011/1...yperinflation/



Quote Quote by AlephZero View Post
That is very unlikely under any set of assumptions. The only way to sustain debt in the long term is for the economy to grow faster than the debt interest rate, (and allowing for inflation). The Eurozone strategy on inflation is to keep it low (say less than 3%). The long term growth rate of the Italian economy has been less than 1%. So the debt is sustainable if 3+1 > 7. Financial engineers spend their working lives redefining the rules of arithmetic, but that's a tough one even for them to justify.
Interesting math but while 3+1 doesn't equal 7 part of the interest on the debt is paid of course from tax revenue. As to weather the debt is sustainable I have no opinion on this yet but here is what the German presendent of the Bundesbank Juegan Stark has to say:
"JW: You are rushing to conclusions in saying that the interest rate levels are unsustainable. Of course this level may not be sustainable in the long run if there is a lack of fiscal discipline and economic growth remains low. But in the short run I do not think it is such a big an issue. What we are facing in Italy is an acute confidence crisis, and only the Italian government can resolve that crisis by implementing what has been announced. Italy is very different from Greece in a lot of respects. I’m confident that Italy will be able to deliver."

http://www.americanfuture.net/2011/1...f-last-resort/
MarcoD
#70
Nov13-11, 12:09 PM
P: 98
Quote Quote by John Creighto View Post
Japan was even able to sustain a higher debt to GDP then Greece but Japan has control over it's currency.
I always find the currency argument a bit silly. When it comes to government debt, there is no difference between a haircut, and devaluation of sovereign issued money. There is also no difference between lowering (government) wages and deflation of a currency. All in all, it doesn't matter. Most of the news about breaking up the Euro therefor is completely nonsensical. It'll only blow up a southern economy since they then need to invest in new IT, don't have access to the European market, and don't have access to European development funds.

The difference between northern and southern Europe is production and wealth; some of the southern European countries gambled on that they could grow their economies to compete with the north. Government debt isn't everything, I think if you look at private ownership of investments and banks, the truth -I expect- is that some of these economies (Portugal/Greece) just found out that they can't compete [at least not in the timeframe they thought they could], and now the north simply owns them. That's the real problem since there is no way out of that except for reforming the economies to make them competitive.

Maybe the only way out for Europe is to just implement a federal European army which mostly hires from the poor parts of the south. That manner the rich parts can send loads of money without anybody feeling bad about it.

(Then again, after the army we would need to start a war with, say, Iran, to defend the federal defense budget. And who would want that??? )

(Anyway, I estimate that Japan, like Germany, still has a trade surplus, so they are hoarding cash and buying up the rest of the world. Likewise, the US can run a large deficit since, as the world's reserve currency, more money doesn't drive government bond interest up, but down. What do the Greeks have?)
John Creighto
#71
Nov13-11, 12:16 PM
P: 813
Quote Quote by MarcoD View Post
"3)their will be about 5% deflation per year."

3) I think you mean inflation? My guess is that inflation is probably the worst which can happen;
I did mean deflation. But I meant asset deflation through deleveraging not CPI deflation. The money has to to go somewhere, and if all assets are losing value than cash may be a safe place to keep ones savings. However, after rethinking it why not just stock pile cash if deflation is a fear? So perhaps the nominal risk free rate of return can't fall below zero percent. However, hording currency is illegal and one could still be robbed so perhaps even hording currency isn't risk free.

So even though deflation can help favor currency valued assets like low risk debt it is also true that inflation can reduce real debt. However, unless people have a way of making more than inflation on their investments, assets which yield less then inflation will not be attractive. Banks find government debt attractive at low yields only because they are able to borrow at cheaper then inflation and able to borrow at many multiples of their net worth. They are able to do this because of both governments insures depositors and central banks providing liquidity when needed. This is effectively a subsidy of the banking system.
John Creighto
#72
Nov13-11, 12:25 PM
P: 813
Quote Quote by MarcoD View Post
I always find the currency argument a bit silly. When it comes to government debt, there is no difference between a haircut, and devaluation of sovereign issued money. There is also no difference between lowering (government) wages and deflation of a currency.
This is true in some sense but one approach is much more gradual and politically palatable. There are also some technical differences which I'll discuss elsewhere.

All in all, it doesn't matter. Most of the news about breaking up the Euro therefor is completely nonsensical. It'll only blow up a southern economy since they then need to invest in new IT, don't have access to the European market, and don't have access to European development funds.
Is there sort of a prisoners dilemma going on here. Everyone knows they can benefit from the European Union but everyone is looking for the most advantageous terms.


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