Friday, May 18, 2018

Thoughts from Galicia, Spain: 18.5.18

Spanish life is not always likeable but it is compellingly loveable. 
- Christopher Howse: A Pilgrim in Spain

If you've arrived here because of an interest in Galicia or Pontevedra, see my web pagehere.

Spain
  • Possibly not the most auspicious start for the new Catalan president.
  • More here on opposition to Spain's macho culture.
  • And here's Don Quijones on the issue of the turn-round in the winds which have helped Spain grow impressively in the last few years. At the macro level, that is. DQ points out – as I have – that the good times have been [very] good to some, not so good to many others. Incidentally, I've referred many times to Spain's phony construction boom but I actually prefer his label of her madcap property boom. Which some suggest is about to happen again. Do people never learn? For example that bankers make huge slugs of money no matter which way a market moves. They just don't care. So need to be controlled. Trump, anyone?
Life in Spain
  • Here's The Local's advice on how to properly party in Spain. Might be useful for younger reasons, if any.
The EU
  • Some of us have long thought the EU would eventually collapse under the weight of its internal incongruities, born of different histories, religions, languages, ethnicities, moralities, cultures and economic and political fundamentals. It's not that the original stimulus - avoidance of war – was wrong. Nor that its 'liberal' societal and economic objectives were/are wrong. Rather, it's the speed – and, it has to be said, the duplicity and arrogance - with which it has been progressed. A case, then, of excessive rather than erroneous ambition. First Greece, then Brexit and now these Italian developments make this crystal clear.
  • The essential problem is that post-trauma Germany doesn't want to be in thrall to the rest of Europe (specially the (profligate) southern part of it), and the rest of Europe doesn't want to be dominated by Germany. As it increasingly is. As I say, Italian developments present this dilemma rather starkly. Below are 3 (overlapping) articles by Ambrose Evans-Pritchard on the subject. In the last of these, the language from both Germany and Italy is apocalyptic but I guess things won't come to this. 
  • En passant, it was inevitable that I'd agree with AEP's comment that the EU had lost the UK – maybe – through a mixture of inflexibility, misjudgement and strategic ineptitude. Of course, this is now being matched by the UK government in its negotiations with Brussels over Brexit.
  • Needless to say, I also agree with AEP's comment that: The volcanic developments in Italy doom Emmanuel Macron’s hopes of a "grand bargain" for the eurozone. It's really hard for me to believe that some folk were so optimistic a year ago as to think this had any chance of success in the foreseeable future.
  • And I also agree with his conclusion that: Intra-EMU politics are turning particularly toxic. The project will face an ordeal by fire when the economic cycle turns in earnest. Some of us have always felt this was inevitable.
Postscript, written after I drafted the above . . . Fascinatingly, this article in the NY Times today talks of the fall of the third German empire. The current one. As the writer puts it: The system is effectively imperial in many ways, with power brokers in Berlin and Brussels wielding not-exactly-democratic authority over a polyglot, multiethnic, multi-religious sprawl of semi-sovereign nation-states. And thinking about the European Union this way, as a Germanic empire as well as a liberal-cosmopolitan project, is a helpful way of understanding how it might ultimately fall. Been there, said that.

Finally . . . There's been a spate of articles on attempts in Amsterdam to deal with the modern plague of excess tourism. Reference has been made to the Disneyfication of the Dutch capital. Rather like my acid comment that visiting Granada and Córdoba these days was like going to DisneyWorld.

© David Colin Davies, Pontevedra: 18.5.18


THE ARTICLES

ITALY 1


Populist plans set Italy on a collision course with Brussels

Italian populists on the brink of forming a government remained defiant yesterday as markets trembled over leaked revelations that they plan to write off billions of euros of debt.

Italian stocks slid on the news and borrowing costs increased as financiers reacted to a policy document saying that the Five Star Movement and the anti-migrant League had considered procedures for leaving the euro and writing off €250 billion in debt.

The spread between Italian and German bonds widened sharply — showing a lack of confidence in Italian economic plans — despite the parties claiming that the document had been superseded since it was written on Monday and that they no longer wanted to leave the euro.

Matteo Salvini, the League leader, dismissed the turmoil as a “cynical board game of high finance”, and said in a Facebook video that he was determined to push on with plans for big tax cuts, earlier retirement and a wage for the jobless.

More than two months after inconclusive elections, the League and Five Star are locked in talks to form the first populist government in Europe, with Eurosceptism written into its programme. A year after Emmanuel Macron appeared to curb Europe’s populist surge by seeing off the challenge from Marine Le Pen to win the French presidency, a free spending Five Star-League government in Rome will alarm EU leaders traumatised by Brexit and concerned about nationalist governments in Poland and Hungary.

The document, published by the Huffington Post, also spelt out the Italian parties’ determination to overturn sanctions against Russia.

The draft contained plans for “procedures that allow member states to leave monetary union”, as well as the intention to ask the European Central Bank to cancel Italian government bonds worth €250 billion bought under the bank’s quantitative easing programme.

Claudio Borghi, the League’s economic spokesman, claimed yesterday that the party merely wanted the EU not to count the bonds when it calculates Italy’s debt, which stands at 130 per cent of GDP, second only to Greece.

Lorenzo Codogno, an analyst at LC Macro Advisors, said by merely considering pulling out of the euro the parties revealed “the true extent of their oddity, inexperience and off-track nature”.

The League’s plan to cut taxes has been priced at €80 billion, while Five Star says its wage for the jobless will cost €17 billion in the first year.

Mr Salvini shrugged off all criticism, reminding supporters that Silvio Berlusconi had resigned as prime minister in 2011 thanks in part to a widening spread in bond prices. Claiming that he would rather be a “barbarian than a slave” to Brussels, he said: “The more they insult us, the more they threaten us, the more desire I have to embark on this challenge.”

League officials have said that they are more Eurosceptic than Five Star, leading to tensions. However after Jyrki Katainen, European Commission vice-president for jobs and growth, warned against violating EU spending agreements this week, Five Star’s leader, Luigi Di Maio, condemned “Eurocrats that nobody elected”.

Beppe Grillo, the comedian who founded Five Star, also renewed his party’s calls for a referendum on leaving the euro, a plan that Mr Di Maio had dropped. Adding to the confusion, Mr Grillo told Newsweek on Monday that he also favoured two euro currencies, one for northern Europe and one for southern Europe.

Mr Salvini also attacked the EU commissioner Dimitris Avramopoulos, who called on Italy’s new government not to change its migration policies. “We heard some unelected commissioner say that Italy has to continue to do what it’s always done, or rather, pull its trousers down,” he said. Mr Salvini has promised to expel all 500,000 illegal migrants in Italy and to halve the funds Italy spends on migrant centres, using the cash to beef up expulsions.

He said that a final draft of the alliance’s policies would be ready by yesterday for submission to President Mattarella, who has the last word on forming a government.

ITALY 2

Italy's insurgents enrage Germany and risk ECB payment freeze
The European Central Bank may be forced to sever credit lines to Italy in a drastic financial showdown if the country’s insurgent coalition tears up EU spending rules and subverts the treaty foundations of the euro.
Professor Clemens Fuest, head of Germany’s influential IFO Institute, said the EU authorities cannot stand idly by if the neo-anarchist Five Star Movement and anti-EU Lega nationalists press ahead with revolutionary policies and endanger the stability of monetary union.
Prof Fuest warned that the ECB would have to cut off Target2 credits to the Bank of Italy within the internal payments system, potentially bringing the crisis to a climactic head. “If they start to violate eurozone fiscal rules, the ECB will reluctantly have to act.  It will be like the Greek crisis. Italy will have to introduce capital controls and will be forced out of the euro,” he said.
It would be a massive blow but I think the euro would survive with France and Germany, and Spain still in there. It would be a different euro,” he said.
Boom beckons in Italy as post-austerity rebels slash taxes and spray money. 
Prepare for a roaring economic boom in Italy. Nothing works so marvelously in the short-run as radical tax cuts and a fiscal spree worth 2 or 3% of GDP.
Markets have great trouble pricing political surprises. They misread Brexit even though it should have been obvious that sterling devaluation was a form of macro-economic stimulus. They misread the election of Donald Trump even though he was promising a Keynesian blitz of New Deal infrastructure and rearmament. They are now misreading the economic logic of Italy's bizarre drama. 
Austerity is over. We are going to see some rock and roll at last in this stale eurozone. I am incredibly bullish,” purred one senior Italian banker in the City. He is quietly helping the twin-headed revolution in Rome. 
If you look closely, the anti-euro Lega nationalists in the new coalition are low-tax, supply-side Friedmanites, or an Italian variant of Pinochet’s Chicago boys in Chile if you prefer. What is unexpected is that the Five Star ‘Grillini’ seem to be going along with much of this, and many of them are in any case techno-utopian, libertarian anarchists. 
The stimulus packs an extra punch in a country that still has plenty of slack and a negative "output gap" of 0.7% (IMF estimate). The combined flat tax of 15% on incomes up to €80,000 (£70,000), and 20% for the rich, is a free marketeer’s dream.  It would be no great surprise if hard-nosed Anglo-Saxon hedge funds soon become the loudest cheerleaders of the Lega-Grillini adventure. 
The proposed "citizens income" of €780 a month for all is an injection of high-powered spending money directly into the veins of the retail economy, a bonanza for swaths of the depressed Mezzogiorno. Seen through this lens there is something not quite right about today’s wild sell-off of Italian bond and equities.
Investors are of course in shock. They thought Italy’s rebel twins had been tamed and that there would be no challenge to the European order or to fiscal probity. They awoke instead to read a leaked "contract for government" – albeit an old draft – that spoke of “cancelling” €250bn of Italian debt held by the European Central Bank and re-establishing “monetary sovereignty”. 
The text speaks of an Article 50-style clause offering a “shared and agreed exit path” for any state that wants to leave the euro. It rips up the EU Fiscal Compact. It calls for EU treaty change on the bail-out fund (ESM) and the Stability Pact, and for political control over the Bank of Italy. It demands a drastic reversal of the "Fornero" pension reform, lowering the retirement age again by several years. The "citizens income" has not been watered down into irrelevance as previously supposed. There is to be a concordat with Vladimir Putin. 
In other words, the Lega-Five Star comrades have not backed off on their original pledges after all. Five Star "guarantor" Beppe Grillo drove home the defiant message this week with fresh calls for a referendum on the single currency, and for splitting monetary union into northern and southern blocs.  “It might be a good idea to have two euros,” he told Newsweek. 
The coalition text is being reworked. The €250bn debt write-off is to become an accounting clause to eliminate the ECB’s €300bn holding of Italian bonds from the official debt-to-GDP tally. “It is modelled on the way the ONS treats bonds held by the Bank of England,” said Lega drafter, Claudio Borghi. Needless to say, the ECB cannot accept such a proposal. To do so would be to admit that QE was covert ‘monetary financing’ of states in violation of the Lisbon Treaty, as German critics alleged all along. It would set off an instant challenge in the German constitutional court.
The market reaction to the bombshell leak is incoherent and likely to prove fleeting. While the risk spread on 10-year Italian debt instantly ballooned 16 basis points to 151 there was no corresponding sell-off in the debt of Portugal, Spain, France, Slovenia, et al.  
Either Italy is suddenly a threat to the integrity of monetary union – in which case the entire project is in danger of unravelling – or it is not. There is no plausible scenario where Italy alone blows up while the rest of the eurozone sails calmly on. The country is too big. There is no plausible scenario where Italy alone blows up as the rest of the eurozone sails calmly on
Lorenzo Codogno,  former director-general of the Italian treasury and now at LC Macro Advisors, fears that the new government is now on “a Syriza-like trajectory within Europe” and heading for a disastrous showdown. “They risk losing market access. If bond spreads and bank spreads widen, Italy could face another credit crunch like 2011.”
The counter-argument is that Brussels cannot plausibly risk a confrontation with Italy. Any attempt to bully the Lega-Grillini rebels into retreat – let alone to crush them à la Grecque – risks setting off a disastrous chain of events. The coalition would retaliate by activating its plans for a "Minibot" parallel currency that subverts the monetary control of the ECB and would rapidly call into question the political viability of the euro.
Italy does not require a bail-out. It has a current account surplus of 2.8% of GDP and is a net contributor to the EU budget. The country is not remotely comparable to Greece.
Brussels has at last met its political match. Just as Brexit was the first referendum that the EU could not overturn (though hopes persist), Italy’s revolt is the first act of really serious defiance by a eurozone state that cannot be broken. It would be courting fate for the EU authorities to risk an existential battle with a big EU founder-state when it is already fighting brush-fires across half of Eastern Europe, and after having already lost Britain through inflexibility, misjudgement and strategic ineptitude. 
Brussels will have to put the best face on events and join the pretence that Lega-Grillini fiscal arithmetic mostly adds up. This charade can be achieved by creative use of "dynamic scoring" and penciling in a heroic fiscal multiplier. 
Some €15bn to €20bn can be plucked out of thin air from a fiscal amnesty (another one). A host of tricks and "agevolazioni" are at hand, along with a putative €200bn privatization fund which sounds impressive but will never come to much. Such a smokescreen would let the EU turn a blind eye.
A messy compromise along these lines would allow the Lega-Grillini duet to go ahead with turbo-charged deficit financing. Markets are likely to let them get away with it as long as the eurozone economy holds up and the global expansion rolls on.
In a benign world, the fiscal stimulus will (ostensibly) pay for itself through higher growth. Mr Borghi argues that the debt-to-GDP ratio might actually fall faster from a peak of 133pc through the magic of the denominator effect. It is not impossible.
I have long presumed that Italy would start running into trouble when the ECB switches off its bond purchases later his year and ceases to be a buyer-of-last-resort. The country must finance debt equal to 17pc of GDP in 2019, one of the highest ratios in the world. Chronic capital flight over recent years – showing up in the Target2 liabilities of the Italian central bank – suggests that few obvious buyers are waiting to step into the breach.
Yet I am not so sure any longer. It is possible to imagine a glorious Italian summer stretching deep into 2019 and even 2020 before the music stops. The problem will come in the next global downturn. 
Recession will quickly expose the deterioration in the underlying "cyclically adjusted" deficit. It will then be clear that the evisceration of the Fornero pension reform puts Italy’s long-term debt on an unsustainable and dangerous trajectory. 
Bond vigilantes – capricious as ever – will awaken suddenly. By then German political consent for monetary union will have been stretched to near breaking point. 
Enjoy the Prosecco for now.
ITALY 3

Italy's insurgents enrage Germany and risk ECB payment freeze

The European Central Bank may be forced to sever credit lines to Italy in a drastic financial showdown if the country’s insurgent coalition tears up EU spending rules and subverts the treaty foundations of the euro.

Professor Clemens Fuest, head of Germany’s influential IFO Institute, said the EU authorities cannot stand idly by if the neo-anarchist Five Star Movement and anti-EU Lega nationalists press ahead with revolutionary policies and endanger the stability of monetary union.

Prof Fuest warned that the ECB would have to cut off Target2 credits to the Bank of Italy within the internal payments system, potentially bringing the crisis to a climactic head. “If they start to violate eurozone fiscal rules, the ECB will reluctantly have to act.  It will be like the Greek crisis. Italy will have to introduce capital controls and will be forced out of the euro,” he said.

It would be a massive blow but I think the euro would survive with France and Germany, and Spain still in there. It would be a different euro,” he said.

The German establishment has reacted with fury to a leaked plan by the Lega and the Five Star "Grillini" to overthrow the disciplinary architecture of the euro project, warning that it kills off any chance of German assent to shared debts or tentative fiscal union.

The bottom line is that they are issuing almost an ultimatum. They are saying that either there are fundamental changes to the eurozone, with fiscal transfers for Italy, or they will leave the euro,” he told The Daily Telegraph. Prof Fuest said the original draft text prepared by the two radical parties exposed their ideological reflexes and fatally damaged trust, even if the final text is being toned down. It has confirmed people’s worst fears and had a very bad impact in Germany. How can you have a shared deposit insurance (for banks) with a government like that in Italy? It is just unthinkable,” he said.They are threatening to undermine the Fiscal Compact and the Stability Pact and the entire institutional basis of monetary union.”

German economists have been stunned by radical demands for a cancellation of €250bn (£220bn) of Italian bonds held by the ECB. The clause has since been removed but the damage is done.

Italy’s policy is unmasked. They want others to finance their debt,” said Lars Feld, one of Germany’s "Five Wise Men" on the Council of Economic Experts. Why should there be any risk sharing in EMU if the new Italian government asks for a €250bn haircut? It is time to ring-fence against Italian risk,” he said on Twitter.

Whether the fall-out from "Italexit" really could be contained is an open question. Many think contagion would spin out of control. Furthermore, it is the express intention of some Lega-Grillini hardliners to force Germany to leave the euro by making it unworkable. They would retaliate by issuing a parallel currency within the eurozone and sending troops into the Bank of Italy if necessary. This vastly complicates the picture.

Italy’s Target2 debt within the ECB’s internal payments nexus has become a neuralgic subject. The liabilities topped €426bn in April – 26% of GDP – reflecting chronic capital outflows from the country. The worry is that they might spike to systemic levels in a crisis.

Willem Buiter, Citigroup’s chief economist and a former UK rate-setter, says weaker EMU central banks are little more than currency boards. They can go bankrupt and are not “credible counterparties”. He argues that the ECB may ultimately have to suspend funding lines to “irreparably insolvent” central banks in order to protect itself.

Hans-Werner Sinn, a celebrated economist at Munich University, said there is no mechanism for Germany to retrieve the vast sums that it has sunk into the eurozone, including the €923bn of Target2 credits owed to the Bundesbank. “We will never get the money back. It is already lost,” he said. Prof Sinn said the structure is equally unworkable for Europe’s North and South, leaving both in a state of smouldering resentment. “There is no possible solution to this. The catastrophe is happening. This is going to lead to the destruction of Europe, to say it bluntly. It will also bring AfD (Right-wing populists) to power in Germany,” he told The Daily Telegraph.

The Lega and Grillini were still arguing over the terms of the coalition deal on Thursday. There is no agreement yet on the choice of prime minister. Five Star intends to submit the coalition plan to an online vote. The deal may yet fall apart.

Italy’s constitution gives president Sergio Mattarella de facto power to impose the premier and the finance minister. He can order the government to stay within agreed EU treaties. But these are largely untested waters in the Italian post-War republic. If he pushes too hard, talks will collapse and lead to a fresh elections. Polls suggest that the insurgent parties would increase their votes. President Mattarella must pick his poison.

The volcanic developments in Italy doom Emmanuel Macron’s hopes of a "grand bargain" for the eurozone. The French leader had been gambling that Germany might accept some steps towards economic union, with a eurozone budget and finance minister, if France delivered on economic reform. It was already a hard sell. The Dutch-led "Hanseatic League" of Nordic states warned that they will not be dragged into "romantic” adventures, calling for strict budget rules. Each state must be responsible for its own debt. The Lega-Grillini démarche is the last straw.

Olaf Scholz, Germany's Social Democrat (SPD) finance minister, has warned that much of the Macron plan will never see the light of day. This week he rowed back further, suggesting that there will be no fiscal backstop for the Single Resolution Mechanism until deep into the 2020s. This eviscerates a key pillar of the EMU banking union.

It was wishful thinking to suppose that an SPD finance minister would deviate far from the "Ordoliberal" reign of Wolfgang Schauble. “Macron will not get anything from Germany. Scholz is exactly the same as Schauble,” said Heiner Flassbeck, the former German economic state secretary. The German view is that they are right all the time and the only way to run the eurozone is for everybody to be like them,” he said.

The resounding German "Nein" means the eurozone will remain unreformed and naked when the next global downturn arrives. Little has been done to avert a repetition of the “doom-loop”. Vulnerable banks and sovereign states can still drag each other down in a vicious spiral.

The situation is bleak. Almost a decade after the Lehman crisis, eurozone interest rates are still negative and quantitative easing has reached technical and political limits. The bloc is still in a Japanese "lowflation" trap. Debt levels are much higher. 

Now intra-EMU politics are turning particularly toxic. The project will face an ordeal by fire when the economic cycle turns in earnest.

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