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The Truth about Italy – disaster or not?

by Aaron McCormack on November 10, 2011

Since Italy came right to the fore of the European debt crisis this week, there have been conflicting opinions on just how big a crisis they are facing in the short and long run.  Most news outlets like to focus on the Berlusconi story, complete with smirking references to bunga-bunga parties (see, even I am doing it too…)

Italy’s situation demonstrates the diversity of challenges within the EU – as a country its indebtedness is not as serious as you might imagine because Italians themselves have not built up the same private debt as many other European countries (about 35% of GDP compared to 75%+ in other EU countries).

However, one of the main reasons for this is that a large part of the economy is carried out “under the radar,” euphemistically speaking. So, by keeping transactions in cash and out of public view has meant that Italians have not been able to “throw it on the credit card”.  But it has also meant that a lot of the economy has not been” taxed” by the government and this is beginning to give bond investors reason to question the Italian governments ability to pay the interest on it’s huge debt.  The federal-level government has run a debt/GDP ratio over 100% for a couple of decades without much in the way of rancour.  It owes a total of over €1.9 trillion – and about a third of this needs to be rolled over in the next year or so.  The Italian government is NOT poorly run in comparison to Greece, despite Mr Berlusconi being at the helm.

That lack of personal indebtedness keeps the Italian economy ticking along a little more nicely than those where government and private debt have both peaked.

However, Italy has some serious long term issues – it is demographically challenged with one of the fastest-aging populations and lowest birth rates of any developed country.  It also has lost competitiveness in many industry segments.  The boss of Fiat said that Polish workers can put together a car in about a third of the time for about a tenth of the total costs of an Italian worker.  And whilst Italy produces some of the world’s finest luxury foods and goods, it has little in the way of real natural resources to support itself.

So there you go – land, labour and capital (attracted and put to work by “competitiveness”) all going in the wrong direction.  No wonder growth has been anemic for more than a decade.

This, combined with an “unfortunate” timing of debt rollover, is what really spooks the bond market.  This is despite the fact that the government is not all that badly run (unlike Greece) and there is not a huge balance sheet hole caused by domestic banks (unlike Ireland).

So, yes, Italy is a disaster waiting to happen.  At one level it is for different reasons than Ireland or Greece or Portugal.  But at a higher level of abstraction it is for exactly the same reason – the inability of the sovereign nation to regain competitiveness through economic adjustment due to the constraints of the Euro.

It is one thing to put the small-fry countries of Greece, Portugal and Ireland into economic debt-servitude to save the Euro and Franco-German banks.  It is another to do it to the world’s eighth-largest economy.  This is why the Euro is not going to survive in anything like its current form.

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