A reader responds to a recent column, “FX MATH: Bright Skies And Foreign Flows, If Italy Avoided The Euro”:
“Vincent Cignarella and Stephen Bernard’s article is highly interesting and shows the insanity of the common currency since the same is probably true for Greece.
“I would be highly interested in a similar analysis for the French, who have got a pretty good savings rate, as far as I know, but obviously very bad public spending habits, which could get worse if Hollande were to win the election and to get a comfortable majority in Parliament, events that I believe are likely to happen.
“Many thanks for your attention.”
Werner Strohmeier
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Here is the original item:
By Stephen L. Bernard and Vincent Cignarella A DOW JONES NEWSWIRES COLUMN
NEW YORK (Dow Jones)–Joining the euro may be the biggest mistake Italy ever made.
Before adopting the euro, Italy’s economy, debt-to-gross domestic product ratio and even the path of its currency were moving in near lock-step with the United Kingdom. Today, the U.K. is seen as a safe-haven for European market flows despite economic troubles ranging from an economic contraction to rising inflation. The U.K. pound is up 10% against the euro in the past year, while its 10-year debt is trading 17% above its face value.
By contrast, Italy’s economy is in a steepening recession. During the first quarter, Italy’s economy contracted 0.7%. The country’s prime minister was ousted amid the turmoil and replaced by a technocrat leader who has been forced to follow strict austerity measures as set out by euro-zone officials because of deteriorating fiscal conditions.
But had Italy remained outside the euro it could have continued on a similar trajectory as the U.K., dodging the European deflationary bullet.
Not to mention, Italy has a larger economy than that of the U.K. and a better savings rate.
Looking back, the Italian economy grew by 274% between 1982 and 1998 compared with the U.K., which grew by 213% over the same period. Had Italy not joined the euro and continued to grow between 1998 and 2012 at the average pace it did between 1982 and 1998, it’s debt-to-GDP right now would be 74%. That’s better than the euro-zone darling Germany–which is estimated to be at 79% in 2012–and the world’s ultimate currency safe havens, the U.S. at 107% and Japan at 236%, according to the IMF.
Japan and Italy share other similarities that would make them equally as desirable. For example, each has very high savings rates. That allows Japan to fund itself and avoid the whims of speculative investors. Italy could have been in the same position.
Something else to think about–Italy’s bond market is the third largest in the world, trailing only the U.S. and Japan. During times of crisis, investors clearly flock to the biggest, most liquid bond markets in the world for safety. The Italian bond market has been damaged by being tied to a currency that has been too strong for its economy rather than reflecting its own debt dynamics.
Since the beginning of the euro, the common currency has strengthened 15% against the U.K. pound. If Italy was not part of the euro, it, too, could have seen similar weakness. That would have made the Italian lira even more attractive and could have made its debt even more desirable to the investment community.
Instead, Italy is stuck with a currency over which it has no control and bond investors pushing it to the tipping point where it might not be able to meet debt obligations without further austerity measures.
(Vincent Cignarella is a currency strategist/columnist for DJ FX Trader, with 30 years experience in currency markets including as a bank dealer at major money-center commercial banks. He can be reached at vincent.cignarella@dowjones.com. Stephen Bernard is a New York-based currency reporter for DJ FX Trader with more than seven years experience as a journalist, having previously worked for the Associated Press. He can be reached at stephen.bernard@dowjones.com)
