06.05.2018 0

Italy seats populist government as Reinhart calls Italian debt restructuring ‘unavoidable’

By Robert Romano

Italian President Sergio Mattarella has ended the impasse in Rome and has allowed a new government to be seated, with Giuseppe Conte being sworn in as Prime Minister, the Five-Star Movement’s Luigi Di Maio being named Deputy Prime Minister and Labor Minister and the League’s Matteo Salvini being named to Deputy Prime Minister and Interior Minister.

Snap elections were narrowly averted after Mattarella had rejected the Five-Star Movement and the League’s choice for Finance Minister, Paolo Savona, because of his anti-euro views.

Instead, the coalition government settled on Giovanni Tria, an economics professor out of Rome’s Tor Vergata University while Savona was named European Affairs Minister.

Now the government sets its sights on addressing the country’s €2.26 trillion national debt, which currently stands at nearly 132 percent of its Gross Domestic Product (GDP), according to Eurostat.

Reports in May suggested the Five-Star-League coalition government would pursue a €250 billion debt forgiveness plan from the European Central Bank. The bank issued a statement saying such a plan would violate treaties.

And German Chancellor Angela Merkel has already ruled out such debt relief in an interview with Frankfurter Allgemeine Sonntagszeitung, saying that the Eurozone “should not lead to a debt union.”

Yet, others see some sort of default or debt restructuring as inevitable.

“[I]t is difficult to see how restructuring of Italy’s debt can be avoided altogether,” wrote economist Carmen Reinhart at Project Syndicate.

Right now, unlike other sovereign countries, those countries locked in the Eurozone do not have the power of the printing press that all other advanced economies rely upon. Any other nation would monetize its debt via devaluation or quantitative purchases of government bonds. But not Italy, it cannot depreciate the euro on its own. It is trapped.

Not that monetization would be a panacea. The real culprit for the soaring debt to GDP ratios in southern Europe is the same as in the U.S., which is too much spending and not enough economic growth.

Italy has not grown above 4 percent or even 3 percent since 2000. Slow growth means slow job creation and thus less revenues. Debt behaves accordingly. Back then, the debt to GDP ratio was 105 percent. Now it’s 132 percent.

Similarly in the U.S., the national debt stands at nearly $21.1 trillion, or 105.6 percent of GDP. Consider that is up from 55 percent in 2000, the last time the economy grew at more than a 4 percent inflation-adjusted rate, and 60.6 percent in 2005, the last time it grew at more than a 3 percent rate.

As growth has faltered and millions of Americans lost their jobs and left the labor force — or never entered on a net basis — the U.S. has gone far deeper into debt.

Since 2000, the $20 trillion national debt has grown by almost 8 percent a year. But nominally — prior to adjusting for inflation — the U.S. economy has only grown at an average annual 3.94 percent rate.

If those trends persist by 2037, the national debt would be more than $90 trillion. And if the economy continues to grow at its current slow rate, the GDP would only be $40 trillion — a debt to GDP ratio of more than 230 percent. That’s if nothing changes.

Right now, the difference between the U.S. and other advanced economies like Japan, and the Eurozone, is that the central banks here can monetize the debt, which really is default by another name. In the U.S., the Federal Reserve owns almost $2.4 trillion of U.S. treasuries, up from $790 billion in Aug. 2007 when the financial crisis began.

Again, it’s not a panacea, but the impacts are clear. Here, for now, interest rates are lower, despite this ongoing default by way of debt monetization. The next time there is a recession, watch as the Federal Reserve calls for more quantitative “easing.”

It will be controversial, for certain, but that is the power every sovereign government has. Some might argue that an outright default would be more honest. Economist Adam Smith certainly thought so.  And the inability of debt-stricken Eurozone economies to do so has led to a lost decade, with no true recovery from the previous recession. As slow as the growth has been in the U.S., in Europe it has been even slower.

The problem with such large debts is that they consume so much of the national revenue that it makes doing much else besides making debt payments possible as governments tend to require higher levels of confiscatory taxation to make the payments. This in turn hurts growth even more.

At the end of the day, Italy — and any country so deep in debt it cannot possibly be repaid — should be considering some form of restructuring. They might not come right out and say it, but there it is.

The fact is, it may not take much for some of these economies to falter and fail to make a debt payment. If economic growth is nowhere to be found, and will otherwise remain out of reach when such heavy debt loads are present; if a balanced budget is nowhere to be found, and nobody has any ability or intention to cut spending, then advanced economies can either squander an entire generation of opportunity hoping for relief, or they can act as any sovereign nation would and take their fate into their own hands.

That, at the end of the day, is the choice facing Italy today, the U.S. and others. It’s to either face the reality of crushing debt today, or kick it down the road for somebody else, for some other generation to face. But sooner or later, that reckoning is coming. Italy is but a window into our own future.

Robert Romano is the Vice President of Public Policy at Americans for Limited Government.

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