Unsustainable interest

I have a soft spot for Italy. It’s got style, beautiful scenery, a lot of history and a great people. It plays good football, builds some of the finest cars and has some excellent thinkers. Above all it has wonderful food and wine – let’s get down to basics. I have a number of close Italian friends and a reasonable grasp of the beautiful language. Yes it has had a bad run of politicians and some issues with organised crime but – hey, who’s perfect? Take the plank out etc etc.

Now Italy has to pay 7% to service its debt. Which means that if it had to roll all its debt over in a year, it would pay $200 billion in interest alone, which is 10% of its GDP and 20% of the public finances and, per head, pretty nearly the per-capita income of its 60 million people.  Fortunately not all of its sovereign debt is due to be repaid immediately – the 7% figure was on only $6.8 billion one-year bills – but all the same, this level is unsustainable.

But what does this interest rate represent? Does this mean that the chance of Italy defaulting is 7%? Has someone dipped into their piggy bank to find the money in the first place? Are there better places to stash their stash? Likewise does anyone think that the US is more likely to default on its even bigger debt? Because that’s what the ratings agencies are saying. These nations are collections of people. People are the only part of this world that actually work – organise, build, design, create and generally make things better. Machines don’t, nor does water, oil, tree, whales or anything. So a country of 60 – or 300 – million people is an enormous asset, not a liability.

The answer of course is that the interest rate is totally illusory. It represents some “analyst’s” estimate of how much they can get away with, how much they want to make some poor sod – or country – tow the line and doff their cap.  They reckon that they can get Italy to cough up this amount – or maybe the burghers of Berlin will have to chip in – so they are just maximising their profit. Oh – and by the way, change your government and here’s the list of people we will accept.  It has nothing to do with the money because most of it was ‘created’ by banks in the first place who may be upset because they won’t get it ‘back’ but the only result would be some red faces and slashed bonuses.

You have to feel sorry for these ‘analysts’. If they set too low a rate, their bank will lose out because either they won’t get the return that their competitors are getting or, given that they have to have a little real money before they print the rest, they will run out even of that. If they set too high a rate, then default becomes inevitable so then they lose – the money they printed. It’s just one giant game of poker and nothing to do with real risk.  W ho blinks first?

In my previous post on Excess Interest, I suggested that an interest level is set above which a substantial and increasing proportion of the excess goes to the government on the basis that default by individuals and businesses becomes a social cost. I think this should be applied to international debt as well with the levels set rather lower than for personal or business loans.  The balance going (subject to a lot of reform) to the IMF. That way the members of the IMF need not put their hands in their taxpayers’ pockets but countries could be properly bailed out because Central Banks just cannot.

Meanwhile the effect on the Italian people is drastic, as it is on the Greek, Spanish, Portuguese, Irish. Here in the UK, instead of the markets setting astronomic levels, the government is intent on a scorched earth policy. So poor us! And as we in the West become less affluent, we buy less from elsewhere, we do less work because unemployment becomes rife, everything stops, people starve and wars break out. Will the last person to leave please remember to put out the lights.

All because the banks and ratings agencies – all shady and unelected – decide everything.

Enough.

Government has the privlege to pass laws and get people to accept them. That’s what they should do instead of wringing their hands. Start with the national economies but consider also that nations are only collections of people and the same protection and ideas should benefit them all.

 

14 thoughts on “Unsustainable interest”

  1. I am very concerned if Italy will step up and do the right thing. It will take a lot to happen to change the economy. It will take discipline and a vision.

    1. @krantcents – yes, both discipline and vision and generally in short supply where politicians battle with the electors on one hand and the EU on the other … 😛

  2. Regardless of whether Italy will do the right thing, the die has been cast and all governments are being analyzed for their spending. I don’t think it will be resolved any time soon.

    1. @cashflowmantra – yup – it will tale a long time but there are deeper issues that also need to be sorted out with the Euro. This crisis has shown both the weaknesses and strengths of the common currency. More of this in a later post… 🙂

  3. Yields of over 7 percent were the threshold after which Greece, Ireland and Portugal were forced to seek international bailouts because their cost of borrowing was unbearable.

    It looks like the Italian government doesn’t want to get bailed out. It seems as if the austerity measures are an attempt to avoid possibly much needed help.

    In the long term do you think the austerity measures would prove beneficial or detrimental?

    1. @YFS – as you will gather I am an Italophile. I remember Rome in 1992 when there was an election and being shocked that every type of police and military had blocked the roads to ensure that people could vote. Italy has come a long way since then but since being part of the Euro has been on a spending spree. This has of course been aided by the banks only too happy to write big loans so, as with Greece, a certain degree of humble pie has to be eaten by them.

      The problem is that the debt and the economy are considered to be too big to rescue or fail so it can’t be bailed out. Well I suppose it could be sold to China or something. 🙁 So any banking haircut will affect banks world wide.

      It will be difficult to know whether the medicine is worse than the disease. We can only hope that with all the austerity that will undoubtedly arrive, the baby isn’t thrown out with the bath water.

        1. @YFS – in some ways, yes it is. In sheer volume of money for example and total debt to GDP. But as I have written, much of this debt has been in rapidly created money and so there has been much more money around.

          Overall I think it is just journalistic hubris looking for a headline. Many people are carrying on, flashing a little less of the plastic, keeping their heads down trying not to be noticed. Unlike the 1929 crash, we are much better informed and more resourceful at least technically. It is more difficult to pull the wool over all our eyes. In the 1930s there was genuine and grinding poverty which was the lot of most people of that time. People didn’t understand why but were left scrabbling for lumps of coal on the slag heaps, cardboard in the shoes, bread-and-scrape for the one meal a day. Things like that were much more prevalent then than they are today in our cosy western economies with some sort of safety net, albeit that more a European creation born out of two wars – or really one long one from 1914 to 1989.

          This time may come again in the west – we hope it doesn’t and as long as the banks keep working, it probably won’t for most people.

          Poverty has of course been the life for many people in the so-called emerging and developing economies for a long time but that is another story and not so much to do with present problems. I may write about that in another post… 😕

  4. One concern is that Italy will pull out of the EU in order to escape the drastic fiscal measures required in the bailout. If Italy pulls out of the EU, other countries such as Greece and Spain are likely to follow and the Euro will cease to exist. As a result investors will flock to the US dollar for safety. The effect is a stronger dollar which is bad news for trade deficits and equities.

    1. @Paul – I don’t think there is a prospect of Italy pulling out of anything. It was the Treaty of Rome that set up the European Economic Community (now EU) in the first place. Only 17 countries of the 27 members of the EU use the Euro. It may be that as Italian – like Greek, Spanish, Portuguese and Irish – Euro denominated debt is treated differently to German Euro debt, some realignment should be done within the Euro but I doubt that it will – there is too much political posturing for this to happen.

      Investors may not flock to the USD anyway. You already see that Switzerland has had to place some upper bound on the CHF because investors were piling into that. A high currency may seem a good macho thing to have – and there are advantages – but as you say it can be damaging for business. So the Fed may just take a holiday while there is some inflow but then sell USD or buy back the gold for Fort Knox to keep the value lower.

      You have to feel (only a little) sorry for investors these days – what on earth (literally) do they do with all that money? There is no safe haven, nowhere where they can make a quick buck or two apart from by high frequency trading.

      Maybe the best thing they can do is to give it all away. Which is why I appreciate Bill Gates and Warren Buffett, but that’s another story of course – investors are generally paying with other peoples’ money! 😀

  5. Folk are rightfully concerned as to whether Italy will do the ‘right thing’. But as with personal debt, there is a degree of culpability with the lending institutions as well, apart from the game of charging as much for interest as they can get away with on created money.

    The banks clearly did not understand the architecture of the Euro and somehow assumed that it was underwritten ‘somewhere’. So they carried on lending, which they probably wouldn’t have done so readily to the Lire. To be fair, Ireland is not in that category at all – it has been badly damaged by its relatively large financial services sector, as have we been in the UK, and an enormous property bubble where prices exceeded those in London by a factor of 2 on fairly ordinary new houses, which we saw in Dublin in 2007.

    Politicians only do what they have to to get elected the next time round and as that is always only a few years, they never do what is in the long term interest of the country and people. Maybe Monti and his team of unelected technocrats, mostly drawn from the financial sector, will get a grip but my concern is that in doing so, the future will take a serious hit.

    Unfortunately we can’t clone Italy and try a series of measures to see which one is best. Every country, like every family or person, is different and what works ‘best’ for one may not work for another despite the assurances of economists and the like.

  6. If Italy does not do the right thing, I’m afraid that it will affect US in really bad ways. The stock market could plunge again just like what we experienced back in 2008. I hope it turns around soon.

    1. @USM – did you mean US as a capitalised pronoun or the USofA?

      Either way you are right. And hence there will be enormous pressure on Mr Monti. His set of academics and technocrats have an enormous task.

      But while the problem is theirs, the solution really lies in Berlin. As Saul Eslake writes in the Sidney Morning Herald, it is Germany’s fear of hyper-inflation – understandable but not appropriate – that stands in the way of stabilising the Euro. A modest action by the ECB will give the markets some assurances and stop them charging these unsustainable interests – or as investors call it, yields.

      Let’s hope Merkel sees some sense – or perhaps Germany has a vested interest in keeping the Euro low (for exports and industry) and thumbscrews on the profligate Mediterranean members.

      Take your pick!

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