You know the feeling when you get a text and have to look at it twice to make sure that what you are reading is what you just thought you read.
On Friday morning, I got a message from a friend who was caught in a huge midsummer traffic jam at the Swiss border coming from a family holiday in Italy.
On the main road out of Milan to Lugano in Switzerland, the Italian police, under instruction from the Guardia di Finanza, were stopping everyone.
They were searching all cars, trucks and vans for money – actual wads of euros – because ordinary Italians are now moving their money to Switzerland.
They are panicking. This has always been the case in Italy. At the first hint of a financial crisis, they head with their savings up the road to Switzerland.
When a financial crisis moves from the relatively opaque trading rooms of investment banks to the ordinary people, you know you’re in trouble. In Italy we are seeing not just a run on a bank; this is a run on a country.
Two weeks ago this column opened with the following words: ‘‘Let’s be clear.
The European deal announced last Thursday night is designed to do one thing and one thing only. It is designed to persuade investors to buy Italian and Spanish government bonds.” I thought this deal would fail, but had no idea that it would be blown out of the water quite so quickly.
Now even the average punter is moving His money out of Italy and Spain.
This makes a mockery of the likes of Olli Rehn and the rest of the European elite who claim that the ‘fundamentals’ are strong and that everyone is overreacting.
When you look at the fundamentals, you see that the picture is actually quite frightening and people are right to be cautious.
Italy has a debt stock of 120 per cent of GDP. This accounts for 23 per cent of all eurozone sovereign debt and it needs to be rolled over constantly.
At an interest rate of 2 or 3 per cent, that might be manageable. But at an interest rate above 6 per cent, it becomes an entirely different story.
The problem for Italy is that it has to keep refinancing, even though its budget deficit, at less than 4 per cent of GDP, is among the lowest in the eurozone.
Without debt payments it is running a budget surplus, so it can’t be regarded as being fiscally irresponsible, but when the rate of interest on its debt rises, you begin to see what could happen.
Next year, Italy will need to raise an amount equivalent to 20 per cent of GDP simply to refinance all the debt that is due.
This figure is from the IMF and the bad news is that at 20 per cent of GDP Italy, in relative terms, needs to raise more debt as a percentage of GDP than even Greece.
Suddenly, as interest rates rise, Italy becomes a big – really big -Greece.
But forget Italy’s problems next year and consider what it has to finance in what is left of this year.
Before Christmas, Italy needs to raise €237 billion – and another €296 billion in 2012.
So now you see the euro’s debt problem and how it is spinning out of control. Either the markets finance this – and this week they are signalling that they are only prepared to give the Italians money at above 6 per cent – or someone else has to buy Italian government debt.
That other source of money is the German taxpayer, who from now on everyone assumes will be Europe’s lender of last resort.
This assumption that the Germans will pay is what is driving down Irish bond yields too because certain people are making the bet – a reasonably logical one based on past performance – that Germany will pay. If you believe that the Germans will pay in the end, you might as well sell Spanish and Italian bonds and buy Irish bonds, which are much cheaper because, ultimately, Gunther will bail us all out.
But what if Gunther doesn’t see it this way? What if he says ‘genug’ (enough!)? What if, sitting in his kneipe over a litre of frothy local Weissbier on his parsimonious annual two-week camping holiday in the Schwarzwald, Gunther says: ‘‘Hold on, we can finance the Greeks and maybe the Irish, but the Italians that’s another case.” What do we do then?
Then we must consider plan B.
Already central banks all over the world are making alternative plans.
They are hedging in the age-old fashion – they are buying gold like never before. Central banks are ramping up their gold-buying as they seek to diversify their reserves away from the euro and, of course, the dollar. South Korea became the latest government to disclose a big bullion purchase, saying that it recently bought 25 metric tonnes, more than doubling its holdings to 39 metric tonnes.
Mexico, Russia and Thailand have also been major buyers in 2011.
This year, governments have almost trebled their net gold purchases, increasing their holdings by 203.5 metric tonnes this year, up from a 76 metric tonne rise last year.
Before this year, governments had on balance been shedding their bullion for two decades, during which gold was seen as a relic, with 1988 being the last year that official holdings increased.
Now all that has changed and will continue to change. In short, other central banks are betting that Gunther will not pay and that something will happen to the euro.
Clearly they are betting against the dollar too, but for us Europeans Gunther’s next move is what we are focused on. So let’s see what might happen.
Plan A is based on the notion that the Italians, Spanish, Greeks, Irish and Portuguese will all run huge budget surpluses to pay creditors – in most cases, foreign creditors. This is hardly politically plausible, for a variety of reasons, the main one being that growth, such as it is, will disappear.
Without growth all bets are off, and politicians know that.
Plan A is also predicated on the notion that if we get fed up of running budget surpluses, Gunther will step in and bail us all out.
This is also reasonably implausible.
Why mightn’t Germany do what it did in the 1993 currency crisis, when Germany undertook to buy all French government assets to protect the battered French franc?
Germany didn’t wade in like this for anyone else. All other embattled currencies devalued.
The Franco/German arrangement was described by Bertie Ahern at the time, as a ‘‘sweetheart deal’’, but it was much more than that. It underscored what being at the ‘heart’ of Europe means – it means Germany and France and when push comes to shove, that’s it.
What if, when this debt crisis threatens France, as it will, the Germans say they will help France but no one else?
What if they realise that the reason the markets are selling Italian bonds is because there is no Italian currency to sell? If there were a currency to sell, the markets would express their scepticism about Italian economic policy by selling the currency.
If this were the case, German savers would be insulated from the delinquency of the Italians and others. What if they were to figure this out?
What if they were to come to the conclusion that either they underwrite everything in the euro and thus put themselves on the hook for all of us, or the euro goes and they are off the hook?
This hot August, somewhere in Bavaria, Gunther has a lot to think about as he barbecues his bratwurst over the holiday campfire.
Meanwhile, Guido isn’t waiting around as he bolts for Zurich with his swag.
Is there any chance that the regular contributors to this blog could limit themselves for once to discussion of the above article and more tellingly what they are doing or would recommend that people do to prepare for the upcoming financial chaos?
David what would you be doing with YOUR swag???
@ Mediator,
I bought gold a few yrs back, it’s been steady and is now about to go parabolic. But that’s really only because of the debasement of the euro and dollar due to the printing press/ inflation.
Keep some cash handy if you have it, enough to get you through a few weeks worth of petrol and food.
Buy some silver coins also, they are still cheap enough to invest in.
There is no perfect place to be but at least it’s better than paper money.
Oh and maybe stock up on some food stuffs, pastas, rice etc.
Ellan Vannin.
If Germany doesn’t pay up then the unemployment they have exported along with their goods finds its way home to Deutschland. The Germans lend money to the periphery so that they will buy German goods and avoid the Germans having to deal with their chronic underconsumption problem. That is how all exporters try and purchase a ‘get out of jail free’ card – dump the unemployment on some other poor sop of a country. So the Germans have a simple choice – buy up the periphery debt and sit on it, agree to a transfer payment to the periphery to… Read more »
I think the term “Gunther” is a racist slur , the good German people are hard working, industrious , inventive and prudent. I have many German friends and feel ashamed to be Irish when I speak to them , I try to be more like Germans and less Irish. I save 20% of my salary , I am deleveraging big time and hope to be mortgage free in 5 years. Debt is the biggest problem of the Irish both sovereign, corporate and personal. Only adopting a more German way of life will save us , is it no wonder they… Read more »
David, Germany [State] will probably continue to support the Euro project in some form or other. However, a further note to your article above: the Aeusserungen [expresssions] of the average German taxpayer has taken on a vastly different tone in recent months. In the 20 years I have spent dividing time living and working in Germany; there has been a huge shift in how opinions are published. The Leserbriefe [letters to the editor] in publications such as the FAZ [Frankfurter Allgemeine Zeitung] and the Sueddeutsche are openly highly critical of the behaviour the bailout ‘Laender’. Now, while this is not… Read more »
Folks at the helm really need to start understanding exponential maths. 6% equates to a doubling of the debt in a very short time!!! Gets out of control very quickly
Here’s a quick tutuorial http://www.youtube.com/watch?v=F-QA2rkpBSY&feature=related
“Next year, Italy will need to raise an amount equivalent to 20 per cent of GDP simply to refinance all the debt that is due.” Remember The Stability and Growth Pact (SGP) is an agreement among the 17 Member states of the European Union …. it consists of fiscal monitoring of members by the European Commission and the Council of Ministers and, after multiple warnings, sanctions[3] against offending members. The pact was adopted in 1997,[4] so that fiscal discipline would be maintained and enforced in the EMU. Member states adopting the euro have to meet the Maastricht convergence criteria, and… Read more »
It is important that people in Ireland know that the German Constitutional Court is to issue its decision in Seotember to a challenge by a number of leading professors as to the legality of Germany funding the massive bailout Whatever the Court’s decision, there is huge pressure from the people, parties and miuch of the press, against the insanity of the German role in this. They are continually reminded of 1923, when it took the proverbial wheelbarrel to buy a loaf of bread. They are horrified at the thought of the hyperinflation inherent in what is supposed to be their… Read more »
Come an everybody. We are not going to get out of the mess until government gets a lot smaller in Europe and especially in Brussels. Maybe the Tea Party have one good idea, For me, I’m out of the country, I’m off to S E Asia until the “Penny Drops”.
So where do we go now, withdraw what cash is in the bank and put it under the mattrass or switch to a different currency ?
David, Good read. I reckon the insider / ruling classes / corpocracy / etc, the credit system itself is cornered. If one looks at it from the perspective that the *credit system* functions on the economies future growth. So, the insiders constantly running with their debt now, pay later, scam has a limit. At some point the debt needed to keep the scam running hits the buffers. The future economic growth been there in the future to fund the debt made in the past does not materialize. I reckon we are there. The system is freezing under the debt now,… Read more »
What about the majority of us who live paycheque to paycheque? Most people have little or no savings so there are no worries as to how to protect it by buying for eg gold and silver.
Whats the prognosis for the next year?
Spotted Bertie about 2 hours ago at Dublin Airport, boarding a flight for Zurich. Suitcase looked remakably heavy!
As did he come to think of it!
We’re not going to leave the Euro. Neither is Germany. The Eurozone debt crisis is extremely serious, as is the US debt crisis. Both will ultimately be resolved. Narrowing the budgetary deficit to less than 3% and even running a surplus is something we should be doing anyway. In Europe blue bonds (or cross guarantees) will be the ultimate solution. A properly implemented and monitored stability and growth pact (a la the current troika monitoring mechanisms) will be implemented. We’ve already signed up the the S&G concept – this time it will actually be adhered to. Austerity for another 3… Read more »
Italy is the crux of the issue, G7 member, next president of the ECB. Ireland, Greece and Portugal were sacrificed to save Italy and Spain. One of my Italian friends since 2008 they has been thankful for Irelands bail outs of their banks as he realised the precarious position Italy was in. So its Italy and Spain on one hand Germany and France on the other. The other 13 eurozone economies are all small. The Germans are culturally very different from the Italians. They have different perspectives on life. As are the people in the North and South of Italy.… Read more »
Germany can’t pull out for the following reasons.
1. Historically they were helped enormously after WW11 to get back on their feet and given every chance by France etc. They simply can’t ignore that.
2. They accepted East Germany and powered on, they are not quitters.
3. If they did pull out their currency would be really really strong compared to other EU countries with whom they have forged strong trade links.
This talk of ‘Plan A’ and ‘Plan B’ is based on the assumption that somewhere there exists a rational, intellectual, economic solution to the crisis if only everyone would agree to it. There has been a gradual realization since the election that this is an Existential crisis, not one that economists can solve. However, most economists don’t do existentialism. Sartre’s “indifference of ‘things in themselves’ to the human will” has now defeated the best minds in Europe, so all we can do is sit back and watch what happens. We have plainly lost control, whic presupposes that we ever were… Read more »
On another point if Germany had gone for this Eurobonds and finance ministry earlier then they would prob have had to swap all Greek/Italian debt at 100% of face value under the Eurobonds heading, which is obviously what the markets want. This is hardly fair as greek debt for example was trading at 50-75% of facevalue.
If they hang on and let Greece/Italy etc go bankrupt then they have a much stronger negotiating position with the markets. They can impose haircuts on bonds with private losses. Then after much has been cut, they can go for the eurobonds option.
Buongiorno tutti, The Italian gov is going to reconvene next Thursday to push through the latest emergency budget measures. There is little cohesion among the government parties and the infighting is in crescendo. On southern Italy, the real brakes are organised crime, chronic tax evasion, and corruption. There is also a strong risk of geographical tensions between north and south. Added to this is the fact that the majority of the police and armed forces are from the south while the disgruntled tax payers are, well, from elsewhere. I have changed my mind on Germany. After this morning’s point blank… Read more »
An international renminbi is on the way Over the last year or so, China has taken the first few steps towards making the renminbi an international currency. And it’s done this by taking advantage of the unique status of Hong Kong. As most readers will know, the Hong Kong financial system is completely separate from the mainland one. It has its own currency, which is pegged to the US dollar, and its own central bank. It operates no currency controls and you can freely bring funds in and out of the territory. In contrast, China imposes strict capital controls, restricting… Read more »
Unicredit bank. Italy. Achilles heel.
My own tuppence Italians are now doing what most Irish with some “Swag” and a bit of cop on were doing for the past couple of years – placing it somewhere safer (at least in theory). However we’ve moving past the point where safer is another Fiat currency (ie transferring from Euro to Sterling or opening a german bank account etc…) The gold/silver option is for wealthy people as a safe haven and depending on your attitude towards whats coming, physical gold or silver despite the obvious risks is the way to go as opposed to paper or electronic gold/silver… Read more »
Relax. It’s all sorted. Those that turn the wheels of power know exactly what is going to happen. The solution to the European debt crisis is further European integration leading to a federalist European state. What better way to coerce a eurosceptic populace into joining a United States of Europe than by fear. It has worked with every referendum on EU integration so far but for the final push to end national sovereignty once and for all, only the threat of the total collapse of society will do. There will be no collapse of the Euro or break up of… Read more »
While it is interesting to get this grassroots report from the northern Italian border, I don’t think David’s analysis here is on the ball at all. As usual he is thinking in terms of a Euro break-up; of Germany and France being sweethearts etc; as if They are likely to form some kind of new mini-Europe and leave the rest of us out in the cold. The solution is not and cannot be Germany paying all our debts. There is no nation on earth that can pay all our debts…or in more real language…there is no nation on earth which… Read more »
@dwalsh
you said : ‘The only people who can protect us from the financial markets are our politicians. ‘.
We have no politicians of substance , no leader of greatness and no statesman to follow.All we are left with are elected local councillors ( known as TDs)devoid of power and MEPs who are disjointed and under external power elsewhere in EU .So what voice for protection do you claim to have?
With due respect , you are dreaming on this point alone only.
Gale Force
I believe that Gay Byrne when elected President will bring to us a sense of nationhood and leadership and maybe statesmanship .I hope he will have the wisdom to chose the real team to lead the country where that team will act parallel to the house of commons in dublin and independent thereof with a clear empowered mandate to change our codes of conduct in ~The State.
[…] David McWilliams – What happens if Germany says enough?: On the main road out of Milan to Lugano in Switzerland, the Italian police, under instruction from […]
Hi David, A lot of people are going to conclusions without looking at alternatives. Its simple, Germany doesnt want to bail out Italy because many Italians are living very well thank you very much, and the Germans have a point. On the other hand, Germany is in a great position in Europe, having the benefit of the euro, and not having to pay for debt levels through euro-wide bonds. Germany is getting a bit of a free lunch. Lets use supply and demand market forces. Italy, like all countries SHOULD be able to get its act together and balance its… Read more »
It is estimated that perhaps up tp €300 billion is the annual tax evasion in Italy whose National Income is circa €1700 billion( I stand corrected on the exact numbers). What does this tell us? Simply that Italians, when they can, evade their taxes. Why is this so? Many reasons some of them historical, some of them cultural, but in my opinion (strictly grassroots), it is that your average Italian no more thrusts their own state than they feel their state promotes their wellbeing and affords them protection. In essence, while Italians are rightly very proud of their country they… Read more »
A couple of articles ago it was about global imbalance. Next up was, nothing will be the same again. And now, we have to entertain the notion of Germany walking off with the ball. In all of this, there is some notion that governments with keynesian stimulation policies combined with austerity can save the day – e.g. Rep. Tea Party building a few aircraft carriers while cutting health and education :) The reality is now dawning on the bond merchants that governments cannot save the day in the West. There are no policies or fiscal measures that can be deployed… Read more »
I will not be surprised when Germany finally get fed up bailing out the rest of Europe. It was always Germanys ambition to run Europe ever since the days of Bismark. Anyone who has studied history will know this.We are seeing the rise of the commodity based markets . The bottom line is if you have resources you are ok. Unfortunately Fine Fail gave away all ours. Republican party me arse.
Great posts.
Very informative.
Learning all the time here.
Switzerland is taking steps to manage/prevent this inflow of capital. Abnormal capital inflows are a huge problem for any economy, causing bubbles and crashes and currencies that are too strong, discouraging tourism, exports and foreign business activity. Switzerland has its own currency so it is particularly vulnerable. Abnormal capital inflows, in the form of ridiculous loans to Irish banks by EU banks, are what caused the irresponsible lending and real estate bubble/bust in Ireland. At bottom the EU is still vastly rich. It has just decided that all its riches would go into bailouts, to irresponsible banks and mildly (Ireland)… Read more »
If the germans do say enough to any more bailout of other eurozone members an admittance that the euro currency created to some way control germany within a neutral currency has proven to be a failure for both Germany who are paying the bill and the european union.
[…] David McWilliams noted in August, what happens if the Germans say enough? Well, they wake up a morality crisis that may not end for any of […]