How Europeans repay their debts these days

How Europeans repay their debts these days

Australia’s pinball politics has nothing on Europe. Because in Europe, the very survival of governments and currencies is at stake.

A spectacular budget battle is playing out in the EU. Problem child Italy can’t get its debts under control. This October, it faces two options.

The first threatens to trigger a financial crisis, a sovereign government default, and the end of the euro.

The second threatens to cause economic destruction, leading to a financial crisis, a sovereign government default, and the end of the euro.

Which do you think they’ll choose?

So far, they’ve gone with the third option. Challenge the EU’s own budget instead.

The Italian government has threatened to obstruct more than a trillion euros in EU spending. The argument is that other EU nations are not abiding by the EU agreement on illegal immigration, so why should the Italians abide by budget expectations?

Italy’s Deputy Prime Minister Di Maio explained on Facebook: ‘we will look at all measures in discussions regarding the European budget and will block what doesn’t work for us’, given that ‘the other states are not doing what’s not convenient for them.

Unfortunately, the Italians can’t stop the EU budget on their own. So next they threatened to defund the EU by not sending in their €20 billion budget contribution.

That kicked off plenty of consternation across the EU and its other members.

At the heart of the battle is not immigration or EU spending. The Italians are posturing about their own national budget. They’re using Trump-style politics, even quoting him as the inspiration for their planned infrastructure spending binge.

Spending more in order to bring down their debts is the option one I mentioned above. The idea is to grow the economy so fast that debt to GDP comes under control.

The trouble is, the EU doesn’t like that option. The planned spending spree breaches the EU’s budget deficit rules. And the EU must approve the Italian national government budget under rules brought in in 2013.

The other difficulty is that this spending must be financed by someone. If the Italians actually try to borrow that much money, who will lend it to them? And at what interest rate?

Back during May’s mini-crisis in the Italian bond market, the economic spokesman of one of the governing political parties explained just how powerful EU and market forces are when it comes to controlling the national politics of its members:

In a way I am very happy because we have finally wiped the bull**** off the table. We now know that it is a choice between democracy or comfortable bond spreads. You have to swear allegiance to the god of the euro in order to be allowed to have a political life in Italy. It worse than a religion.

What we are seeing is the fundamental problem with the eurozone construction; You can’t have a government that displeases the markets or the spread club. The ECB and the Eurogroup will use this to crush your economy.

Which brings us to option two.

Repaying your debts the Greek way

Cutting your government spending, your deficit, your prices, and welfare supposedly fixes your budget. That’s according to the so-called Troika of the IMF, ECB and EU.

The trouble is, things didn’t work out so well in Greece when they tried it.

Barrons magazine has summary of where the wholesome EU and IMF diet left Greece:

If their purpose was to support the Greek economy, the emergency loans must be considered a failure. Since 2008, the economy has shrunk by a quarter, and more than 400,000 Greeks have emigrated. House prices are down 43%. Bank credit to the private sector has contracted by a third. Fixed capital formation after depreciation has been consistently negative since 2010. More than €70 billion ($81.4 billion) worth of assets, including infrastructure, housing, and business plant and equipment, has been destroyed because of a lack of maintenance—a staggering loss for a €180 billion economy.

The results earned the IMF this headline in the UK newspaper the Telegraph after an internal review of how the IMF dealt with Greece: ‘IMF admits disastrous love affair with the euro and apologises for the immolation of Greece.


The EU is now stuck in a pickle come October. If they allow Italy to get away with a spending spree, it risks the ire of the frugal Germans and the ruined Greeks, as well as another funding crisis if the markets boycott.

If the EU tries to crack down on Italy’s spending spree, it risks pushing the country to a bigger revolt. A revolt against the euro and the EU itself.

Italian posturing on the EU budget and immigration is designed to signal that the Italians are ready to do battle. During their election campaigns, the governing parties even threatened defaults, leaving the euro, a referendum on the euro, and plenty more.

What will the EU do?

Relying on an ECB rescue

What caused this mess?

It depends who you ask. And everyone is likely to be right to some extent.

The Italians are not much good with debt and budgets. They’ve had to leave the euro’s predecessor monetary unions repeatedly since 1871. That’s not a typo; it’s a reference to the Latin Monetary Union. Back then, Greece was the other offender.

Italy’s economy has always been reliant on shifty central banking making up for the big spenders at the treasury.

Today, the Italians know they’re reliant on the European Central Bank for their funding.

The problem is, the Germans joined the EU and the eurozone on the condition that this would never occur.

So, transferring the burden for Italian government spending from the bond market to the central bank really just shifts the political problem from Italy to Germany.

This is just the latest example of the inherent problem with currency unions.

The opportunity for abuse is just too enticing.

The nation that isn’t abiding by the rules and continues to worsen its budget deficits can rely on the other nations to bear the burden via the shared currency.

It’s called exporting inflation.

The trouble is, being in a monetary union has other effects.

You no longer have your own exchange rate or monetary policy to help re-balance your economy.

In fact, the exchange rate and monetary policy end up being an awkward in-between for the nations in the monetary union. They are correct for nobody.

When it comes to repaying their debts, Italy’s options haven’t changed. They’ve only become gradually more urgent.

This October, the Italian government must submit its budget to the EU. That’s when the talk is replaced by cold hard figures. And each side must make their move.

Someone must snap. The EU, the Italian government, or the bond market.

Shae and I are preparing a report on this crisis that investigates where we believe it will snap.

It’s never usually the country or institution at the centre of the news.

Contagion always spreads from the periphery. And we believe it will affect Australia in many ways.

And not good ways, either.

Until next time,

Nick Hubble Signature

Nick Hubble,
For The Daily Reckoning Australia