How Italy Could Save the Euro
Yves here. A wee problem is that Eurocrats overwhelmingly are of the view that there’s nothing wrong with austerity; the problem is that countries don’t practice it diligently enough. It’s striking to see how long Germany (and its northern allies like the Netherlands) have been able to run what amounts to a test to destruction for the Euro and Eurozone. Germany insists on running large trade surpluses within the EU, yet is unwilling to lend to its trade counterparts, and is also opposed to more federal level spending to buffer the performance of weaker economies.
As Lars Syll pointed out on the question of Italy’s mini-bot plan (hat tip UserFriendly):
To me, the idea of introducing a ‘parallel currency’ more than anything else shows that the euro crisis is far from over.
The tough austerity measures imposed in the eurozone has made economy after economy contract. And it has not only made things worse in the periphery countries, but also in countries like France and Germany. Alarming facts that should be taken seriously.
Europe may face a future with growing economic disparities where we will have to confront increasing hostility between nations and peoples. What we’ve seen lately — especially in France — shows that the protests against technocratic attempts to undermine democracy may go extremely violent.
The problems — created to a large extent by the euro — may not only endanger our economies, but also democracy itself. How much whipping can democracy take? How many more are going to get seriously hurt and ruined before we end this madness and scrap the euro?
The problem is, as we described long form during the 2015 Greek bailout negotiations, is it would take a bare minimum of three years to do all the coding and coordination needed to introduce a new currency, which given how large IT projects go, means 5 to 6 years at best. It would require coordinated action of the many players in the international payments system. And don’t try strategies like “just do it”. Even introducing a physical currency takes a year, and not being able to move money electronically is tantamount to cutting a country off from trade and tourism.
By Marshall Auerback a market analyst and commentator. Produced by Economy for All, a project of the Independent Media Institute
Italy is now experiencing its third recession in a decade, its economy’s downward trajectory increasingly resembling Dante’s descent into his Inferno’s nine circles of hell (minus the prospects of ultimate redemption). Following the EU rule book to which it promised compliance has “asphyxiated Italy’s domestic demand and exports—and resulted not just in economic stagnation and a generalized productivity slowdown, but in relative and absolute decline in many major dimensions of economic activity,” writeseconomist Servaas Storm.
The sovereign bond buying program initiated by the European Central Bank (ECB) president, Mario Draghi, likely prevented the destruction of Europe’s capital and credit markets and therefore saved the monetary union. As the monopoly issuer, the ECB was the only institution that could credibly make the pledge to do “whatever it takes to preserve the euro.” But Draghi’s monetary gymnastics have been singularly ineffective in restoring his native country’s economic growth, because the ECB’s “aid” is tied to the continued embrace of fiscal austerity by the recipient national governments. This condition was introduced to allay Berlin’s concerns that “profligates” such as Italy would otherwise get a free ride on prevailing low German interest rates, which (in theory) would enable their governments to spend away without consequence, thereby creating a potential Weimar 2.0 within the Eurozone as a whole. Far from creating hyperinflation, however, the arbitrary fiscal rules governing the European Monetary Union (EMU) are actually exacerbating existing disparities by locking countries like Italy into further deflationary impoverishment.
The obvious solution would be to model the EU on a true federal fiscal union such as the United States, Canada, or Australia and therefore better align the political institutional arrangements with economic needs. That was a step too far when the Treaty on European Union (aka the Maastricht Treaty) was ratified to further European integration in 1992. Given intensifying strains between the EU’s historically closest allies today, the political conditions to create a viable supranational fiscal union are even more problematic. There are, however, other ways to resolve Italy’s economic stagnation that rationally get us beyond this mindless adherence to the EMU rulebook.
In a recent interview in the Italian publication Libero Quotidiano, former Prime Minister Silvio Berlusconi mooted the introduction of a parallel domestic currency, the so-called mini-bills of Treasury (“mini-BOTs” for short), which would in theory allow Italy to exit austerity without exiting the eurozone. Italy’s Five Star/Lega coalition government has also embraced the idea. The ECB and the European Commission, predictably, oppose the mini-BOT’s introduction, seeing it as an existential threat to the single currency and a means of avoiding the fiscal rules established at its creation.
Are these fears justified, or can it work? What are the potential consequences—and what forces stand in its way?
The ongoing obduracy of Brussels to any unconventional proposal that goes beyond its tired Stability and Growth Pact (the SGP—the fiscal rulebook governing membership in the single currency union) potentially represents an even greater existential threat to the euro than Italy’s proposed new fiscal experiment. Much like Captain Bligh’s promise that, “the beatings will continue until morale improves,” the European Commission’s overreaction ignores the fact that the economics behind the mini-BOT are sound. They are grounded in a theory known as “chartalism.” Chartalists argue that currencies become money because of the active involvement of the state. Predicating his “functional finance” approach on neo-chartalist insights, the American economist Abba Lerner made the following argument in his essay on money and taxation in the 1947 edition of the American Economic Review:
The modern state can make anything it chooses generally acceptable as money… It is true that a simple declaration that such and such is money will not do, even if backed by the most convincing constitutional evidence of the state’s absolute sovereignty. But if the state is willing to accept the proposed money in payment of taxes and other obligations to itself the trick is done. (Emphasis mine)
Lerner’s key insight is that in a post-gold standard world, fiat currency has no intrinsic value per se. Money is “tax-driven,” and its “value” comes from the state’s imposition and enforcement of a tax liability on its citizens, which in turn creates the demand for people to hold it and use it as the principal economic means of exchange. The key proviso is that the state alone has the capacity to determine what is necessary to pay taxes, and likewise it alone has a monopoly on enforcing that tax liability. Two private parties can agree to use any form of payment that they like (e.g., a cryptocurrency), but they cannot mandate using this unit of account to pay taxes. Only the state can do that.
Determining what constitutes legal tender for the settlement of tax liabilities opens up considerably more fiscal policy space for a national government. Hence the appeal to Rome, as their proposed mini-BOT would give Italy’s government more policy options to generate an economic expansion commensurate with higher incomes and more job growth.
There are past instances of parallel currencies, operating alongside and in support of the national currencies. These have been particularly effective during periods of acute economic distress. For example, in Argentina as the financial crisis deepened after 2000, local governments began to issue “patacones” (bonds with interest) as local currencies to pay workers and suppliers. As Rob Parenteau and I noted,
Utility companies began to accept them—knowing they could pay part of their taxes with them—and acceptance spread even to international corporations such as McDonald’s.” (Emphasis mine)
In the same paper, we also highlighted multiple examples of parallel scrip operating at the same time in the United States during the 1920s:
These were used interchangeably and included:
1. Gold Certificates (redeemable in gold coin until FDR’s prohibition on private citizens holding gold)
2. Silver Certificates (redeemable for coin or bullion)
3. National Bank Notes (issued by US government chartered banks with equivalent face value of bonds deposited by bank at Treasury)
4. United States Notes (issued directly by Treasury and also called Legal Tender Notes, but with no ‘backing’)
5.Federal Reserve Notes (redeemable in gold on demand at Treasury or in gold or ‘lawful money’ at any Federal Reserve Bank, until FDR’s prohibition, when it was just declared legal tender redeemable in lawful money at the Fed or Treasury)
In none of these cases did the countries concerned experience hyperinflation; nor did these quasi-currencies actually undermine the existence of the prevailing national currency.
So on the face of it, there is nothing in the mini-BOT proposal per se which would suggest that it constituted an existential threat to the euro or, indeed, to Italy’s monetary system. In fact, quite the opposite if it is a success, as it could establish a workable template for other distressed member states, assuming the tacit support of Brussels (which could otherwise undermine it, in conjunction with the ECB, as any Greek could attest).
The latter qualifier is key, as the mini-BOT remains highly controversial, both politically and legally. In terms of the latter, many, such as Lorenzo Codogno, a former chief economist at the Italian Treasury, claim that the introduction of a parallel domestic currency would contravene the terms of the European Monetary Union treaty. The Maastricht Treaty itself was not explicit on this point (see here for the alternative view from one of the co-designers of the euro, Bernard Lietaer, who advocated for parallel currencies). The real concern is political, a view typified by Riccardo Puglisi, an economist at the University of Pavia. Puglisi sees the mini-BOT not as a complement to the euro, but rather as “a way to facilitate the exit of Italy from the eurozone.”
Those who share Puglisi’s suspicions are not without cause, given the number of members in the Italian Cabinet who are explicitly anti-euro, notably the minister of the interior, Matteo Salvini (also the leader of the Lega Party in the governing coalition). Concerns remain that Salvini regards the mini-BOT as a means of engineering a full exit from the euro in furtherance of his party’s broader nationalist/populist agenda. So we have the makings of a battle between the custodians of the currency, notably the European Central Bank, versus Italian populists, and other anti-euro supporters of the nation-state, many of whom are calculating that Brussels will ultimately yield on austerity on the grounds that the alternative—an “Italexit”—would represent a greater threat to the single currency and, indeed, a catastrophic step back from “an ever closer union.”
Salvini’s view is by no means the definitive one in the Italian coalition. Neither its technocrat prime minister, Giuseppe Conte, nor the Italian president, Sergio Mattarella, supports full-on exit from the EMU. To avoid a split or constitutional crisis on the issue (which could force new elections), Rome is therefore currently trying to have it both ways, arguing that since there has been no legislation to turn the mini-BOT into authentic “legal tender,” it therefore does not represent a violation of eurozone membership. The vote taken on the mini-BOT was classified as “non-binding.” But ultimately, if the mini-BOT is tacitly sanctioned for use in tax payments by the coalition government, it does constitute legal tender in practice. This is the very essence of what turns the instrument from a being a simple IOU between two private transacting parties to something with much broader national fiscal implications.
Therefore, the coalition is walking a fine line between, on the one hand, proposing a policy designed both to secure a broader national consensus and to mobilize credit badly needed to generate economic recovery and, on the other hand, risking widespread bank runs, if the Italian public begins to fear that the mini-BOT does in fact represent the first step toward exit from the single currency.
There are no signs of bank runs yet, and “lo spread” (the gap between Italian and German bond yields) has not significantly widened to dangerous levels, even though it has recently expanded. So far, it doesn’t appear as if the markets are yet taking the Italian government’s proposal too seriously (and based on the coalition’s own past fiscal timidity, perhaps this is rational). The problem is that absent support from the ECB and the European Commission, former Greek Finance Minister Yanis Varoufakis (who tried to introduce something similar in Greece) gives a taste of the likely outcome, based on his own country’s tussle with Brussels and the ECB:
“Once these short-term notes trade on the open market they would become a de facto currency, a new lira in waiting. Italy would have a split monetary system. The euro would unravel from within. My guess is that the ECB would first ration and then cut off Target2 support for the Bank of Italy.”
If the Italian government still didn’t fall into line, capital controls would be the inevitable result as well as outright expulsion from the single currency, argues Varoufakis.
The question is: who gets hurt more in these circumstances, the Italian government (which would now have full fiscal freedom to counteract the impact from expulsion), or the creditor nations of the euro? Consider that French banks hold “around €385 billion of Italian debt, derivatives, credit commitments and guarantees on their balance sheets, while German banks are holding €126 billion of Italian debt,” as of Q3 2018, according to a Bank for International Settlements (BIS) report, cited by Servaas Storm in his appropriately titled article “How to Ruin a Country in Three Decades.” An “Italexit” could therefore generate a European-wide banking crisis.
In the past, whenever a country has breached the rules of the SGP, a kabuki-like ritual has been played out. Much like the old Soviet Union joke—“They pretend to pay us, and we pretend to work”—the Brussels-based European Commission issues a rebuke to the offending country, which, after token resistance for home political consumption, eventually responds and promises to adopt spending cuts to bring them back into compliance. These cuts (if they are in fact implemented) become self-defeating in practice because they can deflate economic growth. Absent an improvement in exports, or an expansion of private debt (which is difficult to do when both borrowers and lenders are already stressed), the problem becomes worse as stagnation is perpetuated and public debt levels continue to rise (via rising unemployment—less taxpayer revenue—and correspondingly increased social welfare payments).
Italy is a perfect illustration of this conundrum. As Storm argues, the country did more than make token efforts to comply: “After 1992, Italy did more than most other Eurozone members to satisfy EMU conditions in terms of self-imposed fiscal consolidation, structural reform and real wage restraint.”
The reward? Perpetual economic stagnation, including the onset of yet another recession today. Storm quantifies the overall damage:
Until the early 1990s, Italy enjoyed decades of relatively robust economic growth, during which it managed to catch up with other Eurozone nations in income (per person)… In 1960, Italy’s per capita GDP (at constant 2010 prices) was 85% of French per capita GDP and 74% of (weighted average) per capita GDP in Belgium, France, Germany and the Netherlands (the Euro-4 economies). By the mid-1990s, Italy had almost caught up with France (Italian GDP per person equaled 97% of French per capita income) and also with the Euro-4 (Italian GDP per capita was 94% of per capita GDP in the Euro-4.
This growth, however, was reversed in the 1990s, as Italy increasingly embraced the “reforms” demanded for membership in the single currency union. The result of such policies, as Storm highlights, is that “the income gap between Italy and France is now (as of 2018) 18 percentage points, which is more than what it was in 1960; Italian GDP per capita is 76% of per capita GDP in the Euro-4 economies.”
Hence, the rise of the current populist government. What is harder to understand is why this populist backlash paradoxically coexists uneasily with ongoing support among Italians to remain in the EMU. The answer appears to be because many Italians associate the old national currency, the lira, with Italy’s sordid history: a country long synonymous with political corruption, the widespread infiltration of organized crime—in short, a “Bizarro world” that often appears to be the antithesis of a national development state.
To provide one illustration: Italy has the highest proportion of small businesses in Europe. The employment laws discourage the formation of medium to large businesses, which facilitates infiltration by organized crime syndicates, because small shops and businesses are easy prey for them. Large companies such as Eni or Telecom Italia do not pay a “Mafia tax,” but virtually every family-owned business does. This is not the EU’s doing, but a homegrown problem that many fear would become even worse if Italy was left to its own devices again. All of which largely explains why so many Italians still tolerate the country’s economic serfdom under Brussels.
However, this may be a classic instance of the population confusing correlation with causality. As dysfunctional as Italy was in the bad old days, its economy still grew, and living standards improved in both absolute and relative terms, in spite of the Mafia, domestic terrorism, or widespread political corruption.
What changed post the Maastricht Treaty and the corresponding introduction of the euro was the reversal of Italy’s rising living standards. The country’s older political and social pathologies still remain unresolved; membership in the single currency union didn’t help there. The only thing that changed was that the replacement of the lira with the euro turned a once sovereign nation into a quasi-colony forced into a seemingly perpetual fiscal straitjacket. Consequently, Italy now has the worst of both worlds.
Rome still has a few months before it has to respond to the Brussels report (which could ultimately lead to the coalition government facing significant financial penalties, if it fails to implement the requisite budget cuts to comply with the eurozone’s fiscal rules). The government has already rejected the threat, but that’s also nothing new as the two sides went through this same dance with Brussels just last autumn.
There is, however, a new complicating variable today. The current ECB president, an Italian, Mario Draghi, is stepping down in October. So we’ll be in a situation in which a new ECB president (possibly a German, Jens Weidmann) will have his/her credibility immediately tested, at a time when an increasingly powerful populist government’s own mandate to deliver growth could well be at stake. Perhaps, much as it was the lifelong anti-communist president, Richard Nixon, who initiated America’s opening to the People’s Republic of China, we need an anti-inflation ordo-liberal German as head of the ECB to facilitate real change in the Eurozone. That would certainly make the political calculus less predictable, the outcomes more binary: a “disaster” or a “blessing,” argues Martin Wolf of the Financial Times.
The “phony war” will end soon. The parallel currency at least offers a fresh approach to reverse Italy’s relative economic decline. However, the European Commission’s reluctance to tolerate any degree of experimentation, its politically tone-deaf browbeating of the Italian government to fall into line with prevailing economic orthodoxy actually feeds the anti-establishment and anti-euro forces now politically ascendant in Italy.
The ingredients are therefore in place for a conflict as serious as any that has taken place in Europe during the past half-century, lest more creative economic statesmanship is demonstrated in the months ahead.