It was a really ugly week for the Italian economy. Not only has the stock market plunged, but, above all, the difference between interest rates on our debt vis a vis the German debt reached 300+ basis points, thus reaching Ireland and Portugal’s levels of a few months ago. An increase of this magnitude, if sustained over time, makes it almost impossible for the rehabilitation of our budget.
With a debt of around 120% of the gross domestic product, each rise in interest rate forces us to endure very heavy sacrifices. The uncertainties and divisions among the European leaders are certainly the main reason for these repeated strains of the financial markets. However, the weight of these events is the consequence of international speculation heightened by growing tensions within the Italian government. Everything started with one of the usual statements of a rating agency (Moody’s in this case) that has downgraded the level of Portuguese bonds to junk.
Italy has nothing to do with it, but, as often happens on these occasions, a speculative attack came from all directions. Because of our weaknesses, such an attack is particularly hard against our public securities and our bank stocks. Although there was no sign of special news for our finances and Italian banks, we are much less in debt to risky countries with respect to German and French banks. Italian banks are in no way indebted to Greece, Ireland and Portugal, while France and Germany banks are up to their necks in debt. Italian banks have an overall problem: they are Italian.
The way and the timing in which these rating companies’ judgments were made known, have rekindled the debate on the political role that these agencies have taken. Indeed, there seems to be an increasingly justified suspicion that, given their American origin, European states are judged differently with respect to the treatment of the United States. In fact, the American economy is worse than the worst European countries, so much so that the International Monetary Fund declared, at their last mission, “the dynamics of American national debt is totally unsustainable.” Modifications needed to straighten out the United States budget is, in fact, infinitely more burdensome than what is necessary to bring order to the Italian economy. Yet not even the smallest alarm is raised on the creditworthiness of the U.S. debt.
Very likely, excessive trust is given to the known practice of “quantitative easing”. Washington can print money, being sure somebody will buy it. Now this privilege is less certain than in the past; still, credit-rating agencies believe USA’s debt will be eventually financed. Thus, the risk of default is neglected; and consequently the top rating is awarded. The interest rates remains low and the circuit is closed. Trust, evaluation, risk and budget financing are all mutually underpinning. The credibility of this mechanism is now questioned. It is accused of being partial and unable to foresee future collapses. In any case a new methodology is to be developed with some comprehensive factors in the basket. Overall, it also should reflects the new balances witnessed in the international arena, where emerging countries ask for a bigger say on the global issues.
I understand that farm animals are equal, but the opinion that inappropriate metrics are used in Brussels and in all European capitals is growing dangerously. I do not think the proposal to create rating agencies supported by European governments is a wise proposal, because it would further highlight their political nature, but it is certain that if new competitors are not acting in European markets (being either European or Chinese or Indian) the assessment metrics would certainly be less suspicious.
Internal government tensions, then, have unfortunately offered many reasons to the speculators of Italy’s downfall. A budgetary law that postpones as far as possible to the future actions of fiscal consolidation should be guaranteed by a stable and cohesive government. Tensions between the various ministers, between the Prime Minister and the Minister of Economy and contradictory political policies among government parties have certainly been the main cause of the second wave of increasing spreads.
Therefore, an urgent remedy is needed for mistakes and weaknesses that, if sustained over time, will make our economic recovery not credible (and therefore impossible). This lack of credibility cannot be blamed on Moody’s or international speculators.
Another important event of last week was the 0.25% increase of borrowing cost determined by the Central European Bank (CEB). It was a decision already taken for granted, demonstrating a commendable attention by the CEB to fight any hint of inflation. However, I would not want this commendable behaviour becoming too commendable. The growth of the euro area, in fact, has not maintained the good prospects in the second quarter that had emerged in the first quarter. While inflation remains modest and finds its origin mainly in raw material and energy prices, the rising cost of living has no positive influence against this. So, I do not understand why opinions are spreading that this increase should be followed by other increases. In order to fix government finances growth, a low cost of borrowing is needed along with an euro that does not continue to increase in value against the dollar. The CEB should give high priority to these objectives, at least until we feel more confident about inflation.