David Fuller and Eoin Treacy's Comment of the Day
Category - General

    Italy Rebel Economist Hones Plan to Ditch the Euro and Restore the Medici Florin

    The once-unlikely and remote prospect of an anti-euro government in Italy is suddenly becoming a real possibility, threatening to rock the European Union to its foundations within weeks. 

    Events in Italy are moving with lightning speed. Key figures in the Democrat Party of premier Matteo Renzi have joined the chorus of calls for snap elections as soon as February to prevent the triumphant Five Star Movement running away with the political initiative after their victory in the referendum over the weekend.

    Mr Renzi has not yet revealed his hand but close advisers say he is tempted to gamble everything on a quick vote, betting that he still has enough support to squeak ahead in a contest split multiple ways and that his opponents are not ready for the trials of an election. 

    It could easily spin out of his control, opening a way for a tactical alliance of Five Star, the Lega Nord, and a smattering of small groups, all critics of 

    The man tipped as possible finance minister of any rebel constellation is Claudio Borghi, a former broker for Merrill Lynch and Deutsche Bank, and now a professor at the Catholic University of Milan.

    "We are coming to the point where Italy must make the real decision: are we for Europe or are we against it?" he told the Telegraph.

    "What is emerging is a list of four parties or groups who all have one thing in common. We all agree that nothing is possible until we leave the euro."

    "Europe has brought us a depression worse than 1929. It has led to entire peoples being broken and humiliated, like the Greeks, all for the sake of preserving the infernal instrument of the euro. This whole disaster has been adorned by a chain of lies, shouted ever louder because they are afraid that the colossal damage they have done will be discovered," he said.

    Dr Borghi said the landslide 59:41 result in the referendum is a shock to Italy's powerful vested interests, or "poteri forti". "They are absolutely scared because none of their tools of control are working any more," he said.

    "They invested huge prestige in the campaign. Confindustria [Italy's CBI], the chambers of commerce, and all of Italy's big employers were for the 'Yes' side. They said the banks would collapse, that we would lose all our savings, and that we would all go to Hell if we voted 'No', but it didn't work. It was Brexit reloaded," he said.

    Professor Borghi said withdrawal from the euro would be messy but there are ways of mitigating the effects, first by creating parallel liquidity and letting it seep into daily life.

    "The Italian treasury has €90 billion (£76 billion) in arrears on contracts. These could be paid with treasury bonds issued for as little as €50, €20, €10, or even €5, giving us time to create a second currency.

    "When the time comes we can then switch to this new currency. It can be done electronically. We don't even need to print paper," he said.

    Prof Borghi said the cleanest option is for Germany to leave the eurozone. If that is impossible Italy can pass a law to convert its debt obligations into lira overnight - or the 'florin' as he prefers to call it, harking back to the days of Florentine ascendancy under the Medici.

    "The losses would shift to the national central banks through the Target2 system," he said. This means the Bank of Italy would repay €355bn on liabilities to eurozone peers (chiefly the Bundesbank) in devalued lira. The Bundesbank would face instant paper losses on its credits - effecting €700bn in the likely event that an Italian exit would lead to a general return to sovereign currencies.

    The sums are in one sense an accounting fiction. The trial run was the collapse of the Swiss franc peg against the euro in January 2015. The Swiss National Bank suffered vast theoretical loses on its holdings of eurozone debt when the franc revalued, but life went on regardless.

    The gamble is that large sums held by Italians in accounts in London, New York, Paris, or Munich, or held in safe-deposit boxes in Switzerland, would flow back into the system as soon as the boil is lanced, and once Italy has returned to exchange rate viability. Foreign investors would view Italy as a far more competitive prospect. 

    "I don't see any disaster. There is no way to smash our currency since we have a trade surplus. If we had a weaker exchange rate we would have an even bigger surplus," he said.

    For Italy's eurosceptics a return to the lira would be a liberation after fifteen years of economic decay that has hollowed out the country's manufacturing core. Industrial output has fallen back to the levels of 1980. Real GDP per capita is down 13pc from its peak.

    A report this week from the statistics agency ISTAT said the numbers at risk from poverty and social exclusion last year rose to 28.7pc, and a fresh high of 46.4pc in South, and 55pc in Sicily - the epicentre of the 'No' vote in the referendum.

    A study by Mediobanca found that Italy's growth rate tracked that of Germany almost exactly for thirty years. The pattern changed with the advent of the euro, which precluded devaluations and led to a slow but fatal loss of labour competitiveness  - like a lobster being boiled alive. 

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    Like the House of Bourbon, the Euro Will Eventually be Broken on the Anvil of Popular Insurrection

    There have been many other things that Europe has got wrong, but the overarching one is monetary union. From this original sin flows so many of our current difficulties. We know this to be true because countries in the EU but outside the single currency, such as Britain and Sweden, have fared much better than those in it.

    So how come the euro hasn’t already collapsed under the weight of its own contradictions? And with populist, nationalistic insurgency in the ascendant across western economies, are we finally approaching the end game?

    The euro is virtually unique in the history of monetary economics in being a currency without a government. Rather it is a shared, or common currency, in which each member notionally has some sort of a say. Europe’s founding fathers knew that monetary union couldn’t be made to work without a high degree of accompanying fiscal and political union, but cynically regarded it as a means of achieving that end. A United States of Europe would be forged in crisis, they figured, driving through the goal of political union against the centuries old instincts of Europe’s many tribes.

    And in theory it could indeed be made to work. But in a confederation of proud nation states which finds it virtually impossible to agree even common deposit insurance, let alone a proper banking or fiscal union, it seems ever less likely.

    No monetary union can last for long without a unified system of deposit insurance. It would be unthinkable, for instance, for London to refuse to participate in  deposit insurance for the country as a whole because there is a bank in Yorkshire which it fears might go bankrupt. 

    Yet that’s precisely what happens in the eurozone; Germany refuses common deposit insurance with Italy because it fears being left on the hook for essentially insolvent banks such as Monte Dei Paschi Di Siena. Similarly, it would be unthinkable for the citizens of Edinburgh to be made wholly responsible in extremis for bailing out the whole of Royal Bank of Scotland. Fiscally, it would break them beyond redemption. But that's essentially how it works in Europe.

    The eurozone pretends to be a fully fledged monetary union while behaving as if it were still a collection of siloed nation states. 

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    Email of the day

    On the Milken Institute London Summit:

    Yesterday I attended the annual Milken Institute London Summit. I was invited by the organizers as a non-paying guest I am glad to say in view of the high registration fee. It was a great day, the organizers did a superb job, and  I have extensive notes  from several sessions that I am sure will be of interest to you and Eoin. I have attached a pdf containing my notes on the opening plenary which was a panel discussion on Brexit. I wrote this up first because I thought it would interest you. It was particularly thought-provoking and entertaining, as you can read! The video of the 1 hour panel is available today online at the Milken Institute website and I have added the URL within the pdf. If you think subscribers would be interested, then please feel free to post the notes in your daily update. Please feel free to name me as the contributor if you wish.

    Other sessions I attended were about finance, investment, healthcare and new technologies. I will send more summaries in coming days.

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    Chinese-Korean group to build $2 billion lithium batteries plant in Chile

    This article by Cecilia Jamasmie for mining.com may be of interest to subscribers. Here is a section:

    Lithium, frequently referred to as "white petroleum," drives much of the modern world, as it has become an irreplaceable component of rechargeable batteries used in high tech devices.

    The market, while still relatively small — worth about $1bn a year — is expected to triple in size by 2015, according to analysts at Goldman Sachs

    That should be great news for Chile, as the country contains half of the world’s most “economically extractable” reserves of the metal, according to the US Geographical Survey (USGS). It is also the world’s lowest-cost producer, thanks to an efficient process that makes the most of the country’s climate.

    Chile is essentially “the Saudi Arabia of lithium,” according to Marcelo A. Awad, executive director of the Chilean brand of Wealth Minerals, Canadian company that also has interests in Mexico and Peru.

    The country, he noted in a recent interview, is perfectly positioned, with ports across the Pacific from the world’s largest car market, China, which is expected to increase electric vehicles production in years to come. There, lithium is also used to manufacture rechargeable ­batteries that power hundreds of millions of smartphones, digital cameras and laptops.

    The challenge for foreign investors, particularly the Asian conglomerate, is to persuade Chilean authorities of making the leap from exporting the white metal to producing lithium batteries at the point of extraction.

    Estimates from the group’s advisors believe opening the proposed plant would make the value of the product 35 times higher than what it could be obtained by just selling it as lithium carbonate

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    Electric Cars May Take an OPEC-Sized Bite From Oil Use

    This article by Jessica Shankleman for Bloomberg may be of interest to subscribers. Here is a section:

    Wood Mackenzie’s view echoes the International Energy Agency, which last month forecast global gasoline demand has all but peaked because of more efficient cars and the spread of EVs. The agency expects total oil demand to keep growing for decades, driven by shipping, trucking, aviation and petrochemical industries.

    That’s more conservative than Bloomberg New Energy Finance’s forecast for EVs to displace about 8 million barrels a day of demand by 2035. That will rise to 13 million barrels a day by 2040, which amounts of about 14 percent of estimated crude oil demand in 2016, the London-based researcher said. Electric cars are displacing about 50,000 barrels a day of demand now, Wood Mackenzie said.


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    Outlook for 2017: Better times ahead

    Thanks to a subscriber for this report from Commerzbank which may be of interest. Here is a section:

    According to a joint study by Thomson Reuters GFMS and the Silver Institute, the global silver market will record a supply deficit this year for the fifth year in succession. However, at 52.2 million ounces (1,623 tons), this is less than half what it was last year (chart 7). Silver demand should have fallen by 9% to a 4-year low of 1,064.6 million ounces (33,109 tons), while silver supply should fall by “only” 3% to 1,012.4 million ounces (31,486 tons). The biggest drag on the demand side is a 24% decline in demand for coins and bars. Jewellery demand is also expected to dip by nearly 8%. Industrial demand, which accounts for around half of total demand for silver, also declines, albeit only slightly. A steeper fall has been prevented by the rise in photovoltaics which is projected to have risen by 11% to a record level.

    On the supply side, 2016 should see the first – albeit slight – fall in global mining production for 13 years (chart 8, page 5). This is because, following the closure of numerous zinc and lead mines, less silver is produced as a by-product. Due to liquidation of hedging positions (dehedging) by mining producers, additional supply has been withdrawn from the market. The supply of scrap silver, however, remained virtually unchanged. Owing to a significant rise in demand for silver ETFs – GFMS assumes net inflows of 71.4 million ounces (2,220.5 tons) for 2016 – and almost as large an increase in exchange-registered stocks, the broader market deficit has increased to 185.5 million ounces (5,769 tons). This is the highest figure since 2008.

    The deficit should turn out somewhat lower due to recent large ETF outflows, though.
    For 2017, Thomson Reuters GFMS and the Silver Institute except silver demand to decline by a further 3% to 1,035.0 million ounces. The supply of silver on the other hand should rise by around 1% to 1,024.8 million ounces. All demand components apart from jewellery are expected to decrease, with coins and bars once again falling the most, dipping by 9%. Industrial demand should fall by 2%, as demand from the photovoltaic sector – in contrast to the previous year – is also expected to decline, meaning that it can no longer compensate for persistent weakness in other sectors. Industrial demand would thus shrink for the seventh year in a row (chart 9). The increase in the supply of silver is almost entirely due to a larger supply of scrap silver, which should rise by 11% in response to higher prices. This will largely compensate for the accelerated decline in mining production by around 2% compared with the previous year. At the same time, de-hedging by silver producers will decline next year, meaning that less supply will be withdrawn from the market. Consequently, the deficit on the physical silver market is expected shrink to only 10.2 million ounces. This would be the smallest deficit since the last surplus year of 2012. ETFs are expected to record inflows of 40 million ounces. The broader market deficit would thus amount to 50.2 million ounces, a reduction of more than 70% compared with 2016.

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    The Euro Has Trapped Poor Countries Like Italy In a Failed Experiment. It Must Give Them an Exit, or Collapse

    Helmut Kohl brushed aside all arguments against the single currency. President Chirac invited me to the Elysee Palace to hear the virtues of monetary union. Seventeen years later, the question is whether their successors will have the vision to dismantle their monumental mistake, now a prime cause of unemployment, stagnation and populist fury. 

    Those of us who were sceptical of the euro argued that a monetary union would inevitably require a political union, centralising decisions about tax and public spending, and that we didn’t want to be part of that.

    While we were right about that, we actually underestimated the problem – the euro has become so damaging and divisive that public opinion within it will not tolerate a political union. So not only was the cart put before the horse, but the horse will not now contemplate even following the cart at a distance.

    The second respect in which the euro has exceeded our worst fears is that it has made some countries, like Italy and Greece, poorer while others get richer.

    We always maintained that forcing many countries to have the same interest rates and exchange rate would be a problem: some would have booms followed by big busts, as has happened in Ireland, Portugal and Spain. The enthusiasts told us that this would be temporary and “convergence” of all the members would follow. 

    Again we sceptics were right. But we could have gone further. Not only are eurozone economies not converging, they are conspicuously diverging. The per capita income of Italians is lower now than in 2000, which is why they are – not surprisingly – getting increasingly restive. In the meantime, the German economy has kept on growing, and the average German is about 20 per cent better off over the same period.

    Why is this? Because the euro is a cheaper currency than Germany would have if it still had the deutschmark, while it is more expensive than Italy would have if it still used the lira. Germans therefore keep exporting easily and running up a surplus, while the Italians struggle and go deeper in to debt.

    Furthermore, the freedom of movement of capital in Europe probably makes this worse – why would you put your euros in an Italian bank when you can invest them in Germany?

    Membership of the euro has thus put the Italians on a permanent path to being poorer. Unless Mr Renzi was going to enact such extraordinarily bold reforms as to raise the productivity of Italian workers to the same level as their German counterparts, there was nothing he could do to stop this.

    His defeat has not made the eventual break-up of the euro more certain, because that is coming anyway. It has simply made it more obvious.

    Leaving the euro, however, is a far more difficult problem than leaving the EU. As everyone now knows, Article 50 provides for leaving the latter. It may be a vague and inadequate rule, on which our Supreme Court is now deliberating at length, but it is nevertheless a rule that provides for getting out.

    The eurozone has no such rule. This is a burning building you are never meant to leave. What is more, you are barricaded in. If you contemplate leaving, you have to face not having any notes and coins of your own; the need to default on debts that will be even bigger when your new currency goes down in value; and the collapse of your banks because being in the eurozone means they were able to borrow money they should never have been lent. 

    Tens of millions of people in southern Europe will increasingly find that they cannot tolerate staying in the euro, but nor can they leave it without great cost.

    Their anger and resentment will only intensify. The question now is whether Europe’s leaders will cling to a project that has failed even more spectacularly than its critics imagined, or have the statesmanship to provide a way out for those who conclude they have to go.

    The euro is going to need a financial Article 50 – a way of providing for exit, which shares the costs of leaving and gives international help to those departing a scheme they should never have joined. Of course, the mere admission that such thinking is necessary would damage confidence in the single currency.

    It would mean going back on the dream of the 1990s. That is why no one in authority in the eurozone will want to admit that they need to invent an orderly exit. It is anathema to them – the collapse of their beliefs. But those who have trapped entire countries in a vast, failed experiment have a responsibility to help them get out.

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