The Euro Holds Back the Italian Populist Dream
To be truly sovereign in the modern world, a nation must have its own currency.
We live in a world of fiat currency. This is a good thing, as far too much economic activity in the modern world is mediated through markets to rely on an inflexible commodity standard, such as the gold and silver standards of yore. Gone are the days when every price was haggled over, when much economic activity was home production, and when payment in kind (even of taxes!) was normal. We know from experience that modern economies cannot adjust their price levels quickly and hence that it is the currency which must be adjusted when the “supply side” of the economy is jossled, or the demand to hold said currency shifts. The euro zone countries, as well as countries which peg their currency to that of another nation (Hong Kong-USA, Argentina-USA [in the past], Denmark-Euro &c.) show this to be the case. In principle, pegging a currency is little different from using a commodity, it’s just another asset whose value (purchasing power) rises and falls in a way the sovereign cannot control, or usually, even marginally influence. If the public want to hold more money, say because there’s a banking crisis, well then you had better get them some extra money; a task only possible with paper money whose production is controlled by the state.
The need for country-specific, tailored monetary policy lies at the heart of the economic depression in southern Europe.
How Italy Stands
Italy is among those countries which didn’t see the flow of spending resynchronize with that of Germany following the Global Financial Crisis. We don’t necessarily have a full story for why this was, but it is enough to say that before the recession, Italian spending, unadjusted for inflation, just the Euros which changed hands for final goods and services, was growing steadily, around 3% or 4% per year. The plots below show two measures of this “flow of spending” concept, the first, is current Euro (no inflation adjustment) GDP, and the second is indexed current Euro retail sales. The takeaway is that Italian GDP is growing much more slowly than that of Germany, and only reached the level of the pre-recession high in 2015. Retail sales in Italy, fell in the recession and have stayed at that level.
In a simple world, say that of the Roman Empire, it wouldn’t matter how many copper and gold coins changed hands much. If the Emperor paid a massive ransom to the Persians, draining some big fraction of the empire’s currency (just say it happened for argument’s sake), the price of wheat and slaves and tin would fall in the Roman Imperium, as fewer coins chased roughly the same quantity of goods. There may have been some amount of “price stickiness” in the Roman Empire, but it would only cause a mild drop in economic output, because so much production was done on the farm, for consumption by the family.
This is not the case with the modern Italian state. The chart below shows that two measures of inflation in Italy, corresponding to the flow of spending variables above, have fallen since the recession. One might think: “inflation is bad”, but it seems to be a necessary evil to keep modern economies running smoothly. A small amount of inflation, say under 5% per year, never killed anyone, and it allows for interest rates to be higher, something gold bugs and the Zero Hedge crowd seem to like. Some economies, like Japan before Shinzo Abe, are able to muddle along alright (per capita income grew in Japan throughout the 90s and aughts) with near zero inflation, though even in Japan, the economy has performed better since Shinzo Abe squeezed the central bank’s balls until they produced a greater flow of spending and with it, higher inflation.
Some may doubt that the central bank controls things like the flow of spending or inflation. That is silly. The currency of every country on earth is a man-made construct, it’s just paper or entries in a bank’s computers. Someone has to manage it, the central bank, the government. Depending on how the currency is managed (how much is added to the system, and expectations thereof) affects the currency’s value, and in turn how much of it is needed to buy things. This in turn affects expectations about future inflation and spending. Those who doubt this are advised to read Milton Friedman’s Money Mischief for a more detailed and articulate treatment of the subject. Really everyone should read that book.
The Problem
We have established in the paragraphs above that money is flowing smartly through the German economy, but not the Italian economy. Germany is growing even faster than in the years before the recession, while Italy is hardly growing at all. In general, measured economic growth is needed to create new jobs so that firms will take a chance on young workers. This is doubly true in a highly regulated, nepotistic and unionized economy like Italy. Many birds must wet their beaks, so to speak, for anything to happen in Italy, hence, holding population growth constant, a greater flow of spending and higher inflation are needed in Italy than in Germany. Mark well that I am not saying Germany is “better”, rather that it is different society and that it is unreasonable to expect the economies to be synchronized to the same rate of money production over long spans of time.
Italy did fine under the Euro from the currency’s introduction in 1998 until about 2008. This was not surprising because, in general, the Lira moved with the D-Mark quite closely on foreign exchange markets (say in US dollars or Japanese Yen term) in the pre Euro era, even if the Lira did tend to depreciate gradually vs the D-mark, often in a short period of economic distress which the Banca di Italia offset by easing policy. However the Italian economy required a greater stimulus to get spending flowing again following the recession (which the European Central Bank under Jean-Claude Trichet allowed to happen btw), much more than the core Euro countries of France, the greater Netherlands and Germany needed. Why is this so shocking? Many predicted this would happen.
A careful researcher might figure out why German and Italian response to monetary policy were different before and after the global recession. It may have something to do with the Italian state running deficits in the early Euro years, before they tapped-out their credit line. This is a worthy question, but the answer doesn’t matter much for policy today. We know they are different. We can be confident, based on experience, that if Italy were monetarily sovereign (had a freely floating Lira, as God intended), the Italian central bank could have given the economy enough “juice” in the form of monetary easing, to get a proper flow of money going, as the UK, Iceland and Sweden did through 2011, bouncing back toward full employment.
Possibly Italy would have been able to avoid the 2008–2009 recession all together, as Palestine/Israel, Poland and Australia did, countries with their own money and hence their own independent shot at weathering global recessions. This might have meant an enduring depreciation against the German currency, but following the period of depreciation, we could imagine the Lira to have returned to a regime wherein it moved against the Dollar and Yen much as the other European currencies did before this absurd Euro system was adopted. With modern financial technology, where you can easily use a foreign cash machine with your Maestro or Visa bank card, a common currency is less needed than ever.
The Italian public support the Euro. This is unfortunate if unsurprising as monetary economics is a bizarre, counterintuitive field, something few economists or central bankheads understand well, let alone the man in the street. As with the European Union in general, the Euro currency is seen as a prestige object by most; the currency is taken as proof that a country is worthy to be in the same class as Germany. A currency is a really bad category to get sentimental about. Money is merely a tool to be used toward an end, that end in this context being the shrewd management of the economy such that employment is maintained at a high level so that the great mass of the people have an income and some ability to navigate between jobs, progressing in their career (making full use of their silver talents, to again borrow from the New Testament).
I realize this perspective may be derided as “capitalistic” or even “neoliberal” but to an extent we have to make concessions to the world we live in, you want a job don’t you? Well in this world that means the state must manage the economy. Proper management of a currency used as legal tender in a coherent, integrated economy is a prerequisite for high employment levels[1].
The new Italian government has endorsed the Euro Zone system. Perhaps they see a challenge to the Euro as too much for their already ‘radical’ program to take on. Perhaps they’ve drunken the foul smelling Kool Aide out of Brussels. Failing to challenge the Euro, the root of the Italian malaise, sets Italian populism up to fail, as the Italian economy languishes in a disinflationary rut, hindering the possibilities of 21st century populism in that country. Bring back the Lira, manage it right, and watch the blood rush back to the pallid face of the anemic Italian economy.
Italian youth unemployment stands around 35% and cumulative inflation is far lower over the past decade than it should have been, had you extrapolated from pre-recession inflation trends. This is an unacceptable confluence of statistics. The better part of a generation is not being born, because their would-be parents are unemployed and totally broke. Young people need work, yet Euro-denominated variables which we know the central bank can steer, that play an important role in the employment level and real goods and services production, are unacceptably weak. If Italy had it’s own currency, if this were happening in Poland or Czechia or the UK, the central bank head would be sacked and replaced, or the government voted out, repeatedly, until someone figured out they should do this.
As bad as unemployment is, millions more are stuck languishing in marginal jobs at low wages, all because the grease of appropriate monetary stimulus is not being provided to the intricate gears of the Italian economy, because it can’t be. You see the German and French economies are doing fine. Well maybe there are problems in those economies, but the problems are not due to too little spending. The relevant Euro-denominated variables in France and Germany look good. Were the ECB to throw the Italians (and Greeks and Spaniards) a bone by engaging in a massive monetary easing, it would overheat the northern country’s economies, causing high inflation. This would not be the end of the world, and really would be the brotherly thing for these countries to do for Italy, but no German will tolerate inflation, nor will the big banks in France, with their portfolios of fixed rate loans which assume about 2% inflation.
If you find this hard to pull together, imagine a house with many rooms and one thermostat. Hellas’ room is freezing-Siberian cold, Italy’s is cold and Germany’s room is the perfect temperature. What is needed is a new, independent heating system for the southern countries. A “heating system” like the UK, Sweden, Poland and Hungary have.
The first set of charts in this post show that German GDP is growing robustly and Italian GDP is far below trend. The second chart shows that Italian inflation is systematically below 2%, and lower than Italy has seen in many decades. This is grounds for a divorce, filed under “irreconcilable differences”. You have one currency, one leaver to stimulate or dampen the whole Euro Zone, and many masters.
The New Testament which was/is popular in both Italy and Germany says that “No one can serve two masters”, this wisdom is fitting for this situation. Italy, a club of various historically linked metro areas with claims to outlying rural zones, comprising 60 million+ individuals who can all more or less speak a common Italian language, is dying under this German monetary regime. It simply isn’t working and the costs are too high to keep going down this path.
Closing thoughts
The current populist revolt in Italy, is sadly, likely to fail, or at least greatly disappoint. The migrants currently befouling Italy’s many fine piazzas, preying upon her citizenry and threatening her longterm unique nature will, perhaps, at least be sent away. However, the deep economic problems that beset Italy, namely that the economy is not producing enough goods and services to soak up anywhere near the amount of labor that Italians wish to trade for wages, are unlikely to be soon ameliorated. The Italian state has little scope to stimulate the economy through fiscal expansion, given that it’s euro-denominated debt burden is colossal and approaching the limit of what can be sustained by prospective tax revenues. Instead, Italy needs a massive monetary expansion, something to create a market expectation of an increased rate in the flow of spending. There is almost zero chance the German-run ECB will do this, to use an Italian-Americanism: fahgettaboutit.
As long as the Italians remain under the German monetary boot, there is only one rational economic policy course: attempt to become as economically dynamic as possible. This is easier said than done, probably impossible, and if you could do, would it be worth it? Greece, a colony of the Franco-German-European Union, has been subjected to a broad range of neoliberal reforms, in an attempt make prices and wages more flexible, and allow the country to operate more efficiently at it’s meager level of money-spending flow. Yet even in Greece, run as a puppet regime from Brussels, this effort has largely failed, as Greek prices have flat-lined for about a decade rather than falling the approximately 30% they would need to clear markets and restore full employment. The Greek economy is totally disabled, and every year Greece becomes more and more a failed state.
Italy is much more dynamic than Greece, with it’s big, sophisticated global companies, Italy is able to generate endogenous flow-of-spending increases, just not enough.
Why can’t Italy go back to the archaic days of….1997 and not be in the EMU? Why can’t Italy have its own currency, the way tiny countries like Iceland and Singapore do? This is Italy after all, the grand peninsula shaped like a boot, seat of the ancient Roman Empire and home to much later greatness. Why should they want to share a currency? Surely they have given the Euro a go and can’t be blamed for concluding it hasn’t worked out. The Italian people have said democratically that they want a populist government, focused on the Italian people, not random strangers from a world away who have nothing to do with the place. They want a government unbeholden to a crackpot scheme from the 1950s (the European Union). If they are serious about this dream, then it is time to bring back the Lira and re-empower Banca d’Italia.
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1. Interestingly, the appropriate area for a currency isn’t always a country. Some have compellingly argued the USA should have two currencies, in a perfect world, one for the west coast and mountain-west states, and one for the eastern two thirds of the country. Germany and France seems to function fine under a common currency, similarly the former Soviet Union seems to be a natural currency area.
