Sign up with your email address to be the first to know about new products, VIP offers, blog features & more.

Italy, Again, Still

“……the bad-loan problem is mainly due to a 25 percent plunge in industrial output in the six years through 2014.

Italy’s GDP remains about 8 percent below its pre-crisis peak reached in 2007.” (link)

Back in 2012 and 2013, I wrote that the European common currency, the Euro, would fail. I wrote that a Europe strapped into a common currency designed for political reasons would prove itself to be unworkable for economic reasons. Countries like Italy could not be locked into the same currency as Germany. I wrote that Italy needs its own currency so it can continuously devalue to keep the cost of its goods competitive with those from Germany (devaluing a currency makes everything in a country cheaper for everyone outside of that country). Before the Euro, Italy was able to devalue its currency, the Lira, and thus keep the price of its goods relative to the price of German goods and services. However, the Euro locked Italy and Germany into the same currency. While the cost of Italian goods rose, Germany’s cost held steady. Instead of facilitating trade, Italian industries were outcompeted and hollowed out. Italy began to import more and export less. (Un) Fortunately, because Italy’s currency was now the Euro and devaluation was not possible; banks everywhere were willing to lend Italy money without abandon. While exports (earnings) and their industries declined, the government bloated up with debt/spending to fill the void left by their declining productive sector. Government expansion (and government debt) maintained the illusion of economic activity. The problem was solved (or better, put off) for a while. Government did what government does best; it makes things worse.

Then the European Central Bank (ECB) stepped in and, you guessed it, made things worse. The ECB decided to buy massive amounts of bonds from all the European nations and flood the system with money with the intention of reviving these economies. This has put off the inevitable default of the massive amount of debt Italy found itself in. Of course, this has not worked. Italy has not defaulted, but it’s economy is sick because political forces are strapping it to the death grip of the Euro. In order to compete, Italy must lower its costs. Instead, the current plan is to remain in the Euro and grind down wages, benefits and everything else (austerity). This is not working and will most likely end in a popular revolt. On the other hand, if Italy was to leave the Euro and pursue its own currency, Italy’s new currency, the Lira would devalue. Devaluation would immediately realign relative prices. The cost of Italian goods and services would become cheaper while the costs of creditor nations goods and services such those from Germany would become more dear. Floating currencies adjust to keep countries competitive and thus working without grinding ‘austerity’.

Today, Italy is sick. The economy has not grown in years, government debt has exploded, and the banks are full of defaulted loans. Italians are increasingly holding cash and/or gold because their banks are failing. Non-performing loans are approaching 20% of total gross loans; and under the current European Laws, the Italian government is not allowed to bail out the banks. So many depositors could lose their savings.

Watch Italy. As I wrote about several years back, the Euro is a failed experiment. The partial breakup of the Euro is not the end, it is the beginning. The immediate pain of going back to a devalued Lira will free Italy from past mistakes and reset its economic path to future growth. Currency exits have happened before and devaluations are commonplace. It is inevitable. A devalued Lira will make vacations in this beautiful country a bargain and a flood of tourists will put Italy on a road to recovery.