Saturday, April 06, 2013

Probability of Euro breakup in medium term is very low

I think the probability of a Euro breakup in the medium term is very low. What happens in the longer term after a decade or more, of low growth as Europe adjusts to a lower standard of living than experienced in recent decades, who knows, if we're not dead.

In the medium term, the system would likely be able to handle the departure of a small member, in particular after the July 2012 commitment by Mario Draghi, ECB president, to do "whatever it takes to preserve the euro. And believe me, it will be enough," through unlimited purchases of bonds in the secondary markets; the euro accounts for about 25% of global currency reserves and crucially, the peoples of struggling economies will not rush to re-embrace currencies that were synonymous with gouging by elites, high inflation and poverty.   

Developing economies have cut the share of euros in foreign currency reserves in 2012, reflecting a reaction to Europe’s sovereign debt crisis.

The International Monetary Fund's report on currency reserves held by countries around the world, show that developing economies offloaded some $45bn worth of euros in 2012 and have sold almost $90bn worth of euros since the second quarter of 2011.

The IMF report indicates that the recent downturn in euro holdings marks a break following more than a decade of growth among developing nations. They now hold just a quarter of their foreign currency reserves in euros, a drop from 31% in 2009 and the lowest level in a decade, according to the Financial Times. The dollar has held steady at about 60%.

China would be very reluctant to abandon the euro.

The support of almost three-quarters of Italians for retaining the euro in a post general election poll as reported by Corriere della Sera, at least shows that there is little faith in returning to the lira. Alexis Tsipras, the leader of Greece’s SYRIZA (Coalition of the Radical Left) and maybe the next Greek PM, is not advocating quitting the euro.

Italy is the big risk with gross debt of 127% of GDP (gross domestic product) -- the highest since Mussolini came to power in 1924.

Italy does have a growth crisis having grown an annual average 0.3% of GDP in 2001-2010. However, it has run primary surplus (before debt servicing costs) for many years and its budget deficit is quite small.

Crucially, household debt is under control and while interest on the debt takes 5.5% of GDP, that is half the 1990s ratio.

Italy’s GDP growth of less than 3% in 2011-2010 compares with that of France, with about the same population, by 12%. The gap perfectly reflects the difference in hourly productivity - - stationary in Italy, up by 9% in France. Italy’s disappointing performance was seen in the country as a whole, North and South alike.

In the course of a decade, Italy received foreign direct investment inflows equal to 11% of GDP, compared with 27% in France.

Italy could leave the Euro and have an exports bonanza just like the UK got from the collapse in sterling with its rounding error exports value to China?

Italy's unemployment level is as bad as it was in the mid 1990s and the youth unemployment crisis has been unchanged for 40 years.

So austerity could be ended but what happens then?

While Italy has several global brands and 70% of the workforce are in the service sector, The Economist said in 2011 that unlike Germany, it has run a current-account deficit every year since 1999 and a trade deficit since 2005. Italy may still have the world’s sixth-largest industrial base, but Britain, often portrayed as an industrial weakling, makes and exports more cars than Italy does.

So to the inconvenient truth, Italy’s destiny is mainly in its own hands. Outsiders can only have a limited impact on a dysfunctional system and the resultant stunted economy.

The rulers tend to be old and nepotism is rife in a system where family-owned businesses are significant.

The average age on taking office of Italy’s 12 prime ministers since 1990 was over 62. 

Italy has been electing clowns for decades and at last month it elected a professional clown.

“The big problem of the economy is a society that combines elements of the Indian caste system with that of the medieval guilds,” Enrico Letta, the PD’s (the centre-left Democratic Party) deputy leader told the Guardian in 2011. “Our watchword is social mobility, particularly for the young, who suffer most if people are co-opted into jobs instead of gaining them by fair competition.”

Absent the euro, at least the clowns would have only themselves to blame.

So many problems to handle: The secondary school dropout rates are about 20% in Italy, and 25% in Portugal and Spain. Spain and Portugal have cut the rates from over 30% by reducing education expenses.

Whether it is fast, slow or no adjustment in the face of challenges ahead, there are no guarantees that current European standards of living can be maintained. There are over 7m with mini-jobs in Germany that enable people to earn €400 monthly without any tax deduction. There are 120,000 Germans over 75 years of age, with mini-jobs because of inadequate pensions.

Don’t criticise the Germans because that is what is also ahead for the outsiders in Ireland.