2023-10-19 08:47:10
Europe is on the way to the Euro Crisis 2.0
States are piling up debt once more, investors are becoming nervous and demanding more interest. The Eurozone’s “Italy problem” is returning.
Causing growing mountains of debt: Italian Prime Minister Giorgia Meloni.
Photo: AFP
In the USA, interest rates on ten-year government bonds rose by 0.6 percentage points within a month, in Italy by 0.5 percent and in France and Great Britain by 0.3 percent.
One main reason is increasing concerns regarding the sharp rise in national debt. It makes investors nervous. Now they demand higher compensation if they give credit to states.
In many large countries, debts now exceed gross domestic product.
And with good reason: national debt is currently rising in important economies such as Italy, France and Japan. Since the financial crisis, most countries have piled up massive amounts of new debt, accelerated during the pandemic, to keep their economies running. Public budgets were inflated and debt levels inflated in relation to economic output.
In many large countries – including Japan, Italy, Spain, France, the USA and Great Britain – debt now exceeds gross domestic product.
The growth in debt ratios in the G-7, the largest industrialized countries in the Western world, is – with the exception of Germany – between 35 and 140 percent since the financial crisis of 2008. A stark outlier among the industrialized countries is Switzerland. It has reduced its debt ratio from 34 percent before the financial crisis to 25 percent of gross domestic product.
The partisan dispute over the debt ceiling and the budget has damaged the credibility of the USA. In August the Rating agency Fitch the creditworthiness of the USA downgraded by one notch from the top grade of AAA to AA+.
In Great Britain the new one had to be installed a year ago Prime Minister Liz Truss resigns following just 45 days in office. With her plan for tax cuts and increased borrowing, she unsettled the financial markets and caused the British pound to collapse.
A “ticking time bomb”
Now nervousness is also growing in the euro area. following the Government of Giorgia Meloni presented the key figures for next year’s budget the interest rate on ten-year Italian government bonds went up. Even Greece can now get loans cheaper.
“Lo spread”, as the Italians call the interest rate difference between Italian and German government bonds, which are considered safe, climbed above the 2 percent mark, above which the markets become restless. On Thursday morning it stood at 2.06 percent.
“The return of the national debt crisis with all its consequences is a likely scenario.”
The Italian government’s plans contradict the rules of the European Union’s Stability and Growth Pact, which should actually apply once more from next year. Accordingly, with the current debt ratio of 140 percent of gross domestic product, Italy would have to reduce its debt by around 4 percent per year. This will not be possible with the Meloni government’s latest decisions.
“A permanent debt ratio of 140 percent is a ticking time bomb. The return of the national debt crisis with all its consequences is a likely scenario,” warns Jörg Angelé, economist at Zurich asset manager Bantleon, in a current analysis of Italian financial policy.
The Italian economy recovered quickly following the slump caused by the pandemic. Unemployment fell to 7.3 percent, the lowest level since 2009. But the recovery was largely the result of a dramatic expansion in government spending, the Bantleon analysis finds.
If the ECB buys Italian bonds in an emergency, it will torpedo its fight once morest inflation: Euro sculpture in front of the former European Central Bank building in Frankfurt am Main.
Photo: AFP
In 2020, the then government of Giuseppe Conte introduced, among other things, the so-called super bonus in order to stimulate the economy, which had been affected by the pandemic. Anyone who renovates their property ecologically will receive 110 percent of the costs reimbursed in the form of a tax credit. The super bonus enjoyed great popularity, triggered a significant increase in construction investments, invited fraud worth billions – and is now tearing deep holes in the state coffers.
“The source of the fire is in Italy, but developments are also going in the wrong direction in France.”
Like the financial crisis, the euro debt crisis and the corona pandemic, the next global shock in Italy will lead to sharp increases in government spending and plummeting revenues, warns Jörg Angelé. “Then the debt level quickly rises to 150 or 160 percent, i.e. to a level that is not far from that of Greece during the euro crisis.” Investors would then have great doubts as to whether this might still be financed.
The rating agency Moody’s currently rates the country one level higher than junk. She will review the rating in November. An increase in the debt ratio would make a downgrade more likely – and thus further increase Italy’s interest costs.
France doesn’t follow the rules either
“The source of the fire is in Italy, but the development is also going in the wrong direction in France,” says Jörg Angelé. He expects that because other Euro countries do not plan to adhere to the Stability Pact for years to come, the rules are likely to be significantly weakened.
Japan, Great Britain and the USA are also carrying mountains of debt, but they have one advantage: they can borrow in their own currency and devalue it if necessary. The risk of a debt crisis is therefore significantly lower than in the case of Italy, which cannot simply print euros but depends on support from the European Central Bank (ECB).
Government bankruptcies are therefore a real danger in the euro area. Since a default by Italy would endanger the entire monetary union, the ECB must intervene if the “lo spread” threatens to increase too much.
In July 2022, the Governing Council of the ECB created an instrument so that the ECB might buy Italian government bonds in such a case. Because it is actually not allowed to finance individual states in order to prevent them from going bankrupt.
Swiss National Bank might come under pressure
There is also another problem: If the ECB buys Italian bonds in an emergency, it will torpedo its fight once morest inflation. The Swiss National Bank would also come under pressure. In such a scenario, the franc would appreciate sharply, meaning that the National Bank would once more have to purchase large amounts of foreign currency in order to prevent excessive appreciation. In an extreme case, a return to negative interest rates would be conceivable.
As historical experience shows, debt cannot be inflated away. Reforms for greater economic growth are easier said than done. In order for the national debt not to get out of control, the highly indebted countries would have to cut spending and increase taxes.
In view of political blockades, necessary investments in climate protection and the energy transition, the progressive aging of society and rising health and pension expenditure, this will be a rocky road.
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