Giancarlo Elia Valori
The day of reckoning has now come for the Italian economic crisis, worsened by the Covid-19 pandemic and the related lockdown.
As the Italian Statistical Institute (ISTAT) showed, 34% of Italian production has been negatively affected. The activity and operations of 2.2 million companies, accounting for 49% of the total, have also been suspended, but 65% of the entire export business has been closed.
This means that Italy’s economic system is changing.
All this has stopped – hopefully temporarily – the work of 7.4 million employees (44.3% of the total number of private employees not directly working in offices) and, along with the fear of coronavirus, it has obviously had a snowball effect, which has soon greatly reduced the confidence rate of consumers and businesses.
Production has been stopped for 34.2% of companies and the same holds true for 27.1% of value added.
Therefore, considering the general lockdown envisaged, the fall in jobs currently affects 385,000 workers, 46,000 of whom are irregular, to the tune of 9 billion euros of wages.
The most affected sectors have been catering and accommodation (-11.3%), logistics, transport and trade (-2.7%).
With sectoral closures envisaged until June, the overall reduction in value added amounts to 4.5%.
The employees affected by definitive closures will be 900,000 approximately, 103,000 of whom are irregular, for a total amount of 20.8 billion euros of lost wages.
That is where the complex and long-standing E.U. issue comes in.
If we consider all the possible and already proposed E.U. funds, we are talking about 100 billion euro of resources, while it is very likely that Italy may have a “firepower” to generate credits and funds up to 300 billion euros. It would need them all and probably they will not be enough.
We should also consider the future 172 billion euros from the Recovery Fund.
The Conte II government has so far mobilized – albeit with badly drafted, superficial and even naïve rules and regulations – about 75 billion euros of resources, all based on budget deficit.
The so-called Cura Italia decree of last March “mobilized” 25 billion euros and 55 billion euros were mobilized with the recovery Decree of last May.
Certainly not everyone has yet reached this money – sometimes not even many of them. The funding to companies – shambolic and all foolishly used through the banking system, which is structurally inefficient – reminds us of what a great Lombard entrepreneur used to say years ago: “What do we industrialists ask of the State? That it gets out of the way”.
The European Funds from SURE, the European Investment Bank and the European Stability Mechanism will mobilize about 270 billion euros throughout the European Union, with a share for Italy equal to 96 billion euros.
They are certainly not enough to rebuild the production system and compensate for damage.
SURE is currently worth around 20 billion euros for Italy alone, but only to finance the Redundancy Fund, while 40 billion euros will be the Italian share of the 200 billion funds provided by the EIB only for SMEs.
Therefore, Italy will go into debt – albeit on favourable terms – but not to get what it really needs.
The rest will certainly have to be borrowed on the financial markets and with our own public debt securities which, however, at maturity will be secondary to the ESM or EIB loans.
Another key problem is that if and when – but it will happen anyway- the standard rules of the Stability Pact are back in place, we will be left with a very high debt, but still liable to all the reprimands of both the “markets” and the E.U. which, at that juncture, may also revise the terms and conditions of the loans already in place.
For Italy, the Recovery Fund could make available the above stated 172 billion euros, of which 90 billion of loans and 81 billion of grants.
At the end of 2020, however, the Italian public debt will rise by as many as 15 points of GDP.
Why? Firstly, because the denominator will obviously be lower: the economic downturn resulting from the coronavirus crisis will be much wider than the one occurred in 2008, with a very severe 5.3% decrease compared to the GDP recorded in 2008.
Currently Confindustria, the General Confederation of Italian Industry, estimates a 6% drop in Gross Domestic Product, while Goldman Sachs estimates a 11.6% fall.
Obviously there is also the inevitable increase in public spending, which is another public debt problem, hoping that speculation will stay calm – which is unlikely. There will also be a sharp drop in tax revenue.
For example, it is estimated that 20% of the professionals registered with professionals Rolls and Associations risks being forced out of the market. It is no small matter. Other associations in the sector provide similar data.
Hence, if we assume a 6% GDP reduction, the debt-to-GDP ratio would rise from the 135% of late 2019 to at least over 153% at the end of 2020.
With an 11% GDP fall, the debt-to-GDP ratio in late 2020 would be equal to 163%.
Obviously, in such a context, even pending the suspension of the Stability Pact, Italy’s debt would be very hard to support.
Here the problem also lies in primary surplus. According to our data, even if we assume a limited 2.5% GDP rebound in 2021, with an unchanged cost of debt (2.6% in this case) there would be the absolute need for primary surpluses of at least 2.3% and 2.6%, respectively, in the case being studied of a 9% fall in GDP and also in case of an 11% collapse.
In other words, the government should cut public spending always below 40 billion euros compared to taxation. This is impossible.
Therefore, we must necessarily monetise the extra-deficit with the ECB – monetise and not postpone payment until maturity – but for a very long period of time and for amounts that will probably be much higher than the current ones. It will also be necessary to issue common E.U. debt securities.
Otherwise the markets, which have already laughed at a currency that has not even a common taxation and a single public budget rule, will pounce on the poor wretched Euro and destroy it.
Then there is the ECB. On June 4, 2020 it announced the expansion of the Pandemic Emergency Purchase Program (PEPP) from 750 to 1,350 billion euros and also its extension until June 2021 and, in any case, until the end of the emergency situation.
However, there is additional data to analyse. Firstly, the current PEPP share mobilized for each E.U. Member State in the March-May 2020 quarter still corresponds, in essence, to the capital key.
The capital key is the mechanism whereby the ECB purchases sovereign debt in proportion to each country’s ECB share. The key is calculated according to the size of a Member State in relation to the European Union as a whole. The size is measured by population and gross domestic product in equal parts. In this way, each national Central Bank has a fair share in the ECB’s total capital.
With two significant exceptions for the time being: France in a negative sense and Italy in a positive sense.
In other words, France is actually supporting Italy’s public debt. Obviously it cannot last long.
Even in the Italian debt case, however, the PEPP share does not seem to be as high as usually believed.
The maximum absorption has long been recorded by the TLTRO purchase programme. Indeed, these are short-term operations and the markets know they will end soon.
What next? There is no alternative option.
Let us not even talk about the possibility that, based on the pressure from the so-called “thrifty countries”, well led by Germany, this mechanism may stop all of a sudden.
There is also another factor that should be better studied in Italy, namely the ruling of the German Constitutional Court based in Karlsruhe.
As made it very clear by the German Constitutional Court, it concerns the ECB programme known as Public Sector Purchase Programme (PSPP).
Created in 2015, it is still operational. It is not yet known for how much longer, to the delight of speculators.
On points of law, the German Constitutional Court challenged the 2018 judgment of the European Court of Justice, in which the Luxembourg judges considered the ECB’s intervention unlawful, but rather deemed that the E.U. Court should only confine itself to the actions and deeds manifestly exceeding the limits set by the Treaties and the ECB Statute.
Therefore, the issue at stake in the current Karlsruhe ruling concerns the principle of proportionality (Article 5 TEU).
Based on the principle of proportionality, in fact, the E.U. can take action in “shared competence areas” (which are listed in Article 4 of the Treaty on the Functioning of the European Union) only if and insofar as the objectives of the proposed action cannot be sufficiently achieved by the Member States, but can rather be better achieved at E.U. level.
Certainly the monetary policy strictly falls within the E.U. and ECB competence, but the ECB’s action has inevitable repercussions on economic policy, which is in any case a shared competence area.
Hence, as the Karlsruhe judges maintain, the issue lies in defining whether the ECB enjoys independence even in relation to the treaties establishing it or whether the ECB itself should in any case follow the principles of the E.U. system to which it belongs.
In essence, it is a matter of keeping fiscal and monetary policy still separate, and this is scientifically difficult. The dream of every badly aged and old-fashioned monetarist.
In essence, however, the Karlsruhe ruling tells us that the Euro area is sub-optimal (as we already knew, since Robert Mundell’s model certainly does not apply to the E.U. and the Euro) and is in any case not representative.
We have already known it, too, and indeed for a long time.
The Euro is now a handicap for most E.U. Member States except Germany.
The system of fixed rates with the European currency enables Germany to be increasingly competitive on the export side, in the absence of mechanisms to readjust foreign trade balances.
Moreover, there is not even a real and homogeneous tax policy in the E.U. Member States, not to mention the ban on funding the Member States’ debt, which was established as far as the Maastricht Treaty.
With a view to avoiding this ECB funding mechanism, which may be rational but is illegal under the E.U. Treaties, Germany basically asks us to sell the public debt securities purchased by the ECB before their maturity.
That is fine, but it only means that a Member State’s debt can never be cancelled by purchasing the securities through its Central Bank.
Hence the securities continue to exist and be painstakingly renewed or possibly continue to re-enter the market.
Facts are facts, however, and without Mario Draghi’s quantitative easing (QE), France, for example, could certainly not have 32% of its public debt been bought back by the Euro system.
When all E.U. Member States’ securities reach maturity, other ones are always purchased, so that the exposure remains around 33% and Germany is happy with this strict compliance with the law.
This 33% limit is self-imposed by the ECB so as to avoid one of the Karlsruhe conditions, i.e. the national voting thresholds, within the ECB, for rescheduling the debt of an individual State.
It should be noted, however, that the ECB funds the absorption of E.U. countries’ public debt with the creation of money ex nihilo, like all Central Banks in the world. Nevertheless, this is still explicitly prohibited by the Treaties, but is barely justified, at legal level, with the aim of curbing inflation.
An economic ideology which is now very old-style, but still very fashionable within the European Central Bank.
The various ECB sovereign debt purchase programmes are already worth over 1,000 billion euros, accounting for 8% of the entire Euro area.
However, with a view to really operating in this area, the ECB must also get rid of the German Constitutional Court’s first ruling of 2017, namely the 33% limit and hence the obligation to put the purchased securities back into circulation immediately after the end of the pandemic.
Reselling, on the secondary market, the securities still maturing would cancel all the monetisation benefits, but a new PEPP will be needed in the future, without quantitative limits and for a long period of time.
And the ruling of the German Constitutional Court and Germany itself, with or without “Nordic” or “thrifty” watchdogs, will certainly get in the way. Hence for Italy (and France) there will not be much room for manoeuvre.
The Fourth Reich is advancing not with the overheated “Tiger” tanks or with the Pervitinephedrine drugs, but with the monetary game on a non-rational currency.
Germany, however, said a very clear “no” to this process of debt repurchase and absorption, precisely with the Karlsruhe ruling of May 5.
The current PEPP is already outlawed under German law. We need to remember it or Germany will make us remember it.
Italy, however, will not survive within the Euro area without QE, PEPP or any other trickery may be devised by the European Central Bank. The same holds true for France, although it still does not say so clearly.
When, at the end of the three months allowed by the ruling of the German Constitutional Court, the Bundesbank withdraws from the purchase operations, it will obviously start again to put several thousand Bunds purchased with the ECB back on the market.
The sales of these securities will make rates rise in Germany, an increase that will be counteracted by the flight of Italian and French capital to buy German debt.
At that juncture, Germany itself will autonomously carry out controls on capital, which is tantamount to paving the way for its exit from the Euro.
What about the United States? At the end of 2019, before the lockdown, the share of speculative debt at high default risk amounted to 5,200 billion U.S. dollars.
Over the last two months of Covid-19 crisis, 1,600 companies a day have gone bankrupt in the United States, while consumer debt – a sort of crazy magic wand for American spending – has decreased by at least 2 billion U.S. dollars per month.
It is a severe drop for those who foolishly live on debt, not to mention that in late 2019 consumption was worth 75% of the U.S. GDP.
Therefore, considering the close correlation existing between consumer credit and consumption – and hence GDP – in the United States, there will almost certainly be a further crisis in companies’ solvency there.
Since 2008 FED’s interventions have been worth 7,000 billion U.S. dollars, and the financial assets on the U.S. market are worth approximately 120 trillion dollars, i.e. 5.5 times the North American GDP.
Hence, not even the United States will give us a chance to find a way out or an exit strategy.
GIANCARLO ELIA VALORI
Honorable de l’Académie des Sciences de l’Institut de France
President of International World Group