merkdraghi2Debt cloak and political dagger in the eurozone

In a two-parter to be completed in the coming 24 hours, The Slog analyses the desperate state of Italy’s finances, its long history of debt accrual, and the clouds that still hover over the political and banking class there. Why would anyone in their right mind be piling into unsustainable Italian debt investment in 2014? Are lower bond rates going to make any difference when the solids hit next year? Is this really a free-market investment play, or part of a bigger game. Decide for yourself today and tomorrow

Hugh Dixon at Reuters told his readers the other day that ‘A constitutional reform deal between the leader of Italy’s largest party and the leader of the opposition addresses one of the country’s biggest problems: its ungovernability.’

When ungovernability is just one of a nation’s problems, you know you’re in trouble. What might the others be, we wonder – imminent barabarian invasion? Ostrogoth II: This time we’re going to eat your pasta.

No, actually: this time Italy’s long-term structural debt problem is going to eat the country’s solvency. Italy is a basket case of corrupt officials, braindead biased media, crumbling infrastructure, and massive dark pools of hidden debt. Just how desperate the country now is was made clear in 2013 when the authorities falsified an entire quarter’s economic statistics. This must’ve left even the Met Police gaping on in awed admiration.

That makes it a nightmare for people like me because, to be frank, whereas the Greeks smile a lot while giving horrendous news, and the Spaniards have an impressive system of shifting the money around – like a minor amdram person playing several roles at once – the Italian authorities think quite carefully about what people want to hear, and then produce some statistics showing just that. It’s a crowd pleaser in the short term, but as the Nazi bigwigs discovered in April 1945, the million men who perished at Stalingrad might still be on the books, but they’re in no fit state to come to your rescue.

An Italian debt that stood at 116% in 2010 is now 127%, and both figures are false underestimates. Italian State accounting is a thing to behold – only not for too long, as your pupils will wind up heading out towards each side of your head. Remember, this is the Nation that not only takes forever to deliver mail: after three delivery failures they pulp it.

Under Berlusconi, huge amounts of money went missing…and whereas in Greece, there are backhanders that dilute the budget but the airports somehow miraculously get built, the bunga-bunga years dispensed with the formality of using budgets for some social purpose: a bit like the mail, they just disappeared. Driving through Italy these days, one gets the feeling of being in a Mad Max movie.

Yet despite this, yesterday Italian bonds were preferred to those of Australia. While I do realise that having a Trappist Prime Minister with the brain of a special-needs koala bear is bound to make the markets a little nervous, such a preference is undeniably potty. Italy (and Spain for that matter) appear to be using this sudden opening-up of unjustified bond market optimism to…here it comes again, kick the can down the road. As I tried to show late last week in relation to Greece, the short-term debt product does exactly what it says on the can: like a pesky rake, it just keeps zapping one on the schnoz at regular intervals in large amounts.

Everyone in the media is delighted because Italy is getting longer-term debt away: its debt costs on 10 yrs are back to well under 4%, the opinion-formers say. In another of those wonderfully gobbledegooked, calm-sounding statements (they always remind me of airline pilot-speak) this is now referred to in the EU space as “stabilising the average debt maturity”. Furthermore, those on-the-ball market experts always called in by the media majors to quote on such things are right up to speed. “Increasing the average life of debt is the big theme of the year for Italy and Spain,” said David Schnautz, rate strategist at Commerzbank in New York. Yessir, 2012 was fingers in ears and 2013 was the 400lb Grillo stalemate, but 2014 will be the year of the bigger cans kicked by leather-booted rugby fullback feet.

The reality, however, is that, given the upcoming maturity timetable, a genuine desire to invest in Italian debt ought to represent a prima facie case for being detained under the Mental Health Act.

A lot of ‘people’ buying Italian debt now are doing so, one suspects, with ulterior motives. I don’t want to go out on a completely dismembered limb here, but I think this may well be what’s going on in some cases. Whoever is buying this junk for whatever reason, it isn’t doing Italy any harm for now: already in 2014, it’s borrowed €1.7bn a 2028 maturity bond at very low cost. The problem comes when things are so badly tits up economically (and rates can only go up) all this frothy 15-20 year stuff being knocked out now becomes irrelevant when Italy defaults on a 3-year 8% bond it took out in 2011.

I have been wittering again recently about the reassertion of at least some fundamentals, and while we can all argue about specifics, there isn’t much of a heated debate about the state of Italy’s economy and finances.But this still doesn’t stop Rentagobs from diving in where Angels don’t even want to think about the smell involved in doing so.

“We have moved up the (yield) curve because we’ve become more certain the periphery was having an economic rebound and we’re still seeing that,” burbled Sandra Holdsworth, investment manager at Kames Capital this week. I’ve no idea how much Rome is paying her to serve that sort of guff, but I hope it’s enough to assuage the shame when she’s proved hopelessly wrong. Italy remains a basket-case. No, that’s unfair: Ms Holdsworth obviously isn’t being bribed, of course not. She’s just more dumbassed than an Australian Prime Minister.

Among the EU big seven, Italy has the highest debt to gdp ratio at 127%; and while the odd piddling billion is being bought on longer maturities now, Italy also has the highest proportion of short-term debt in the Big Seven – at 18%. As this Italian Treasury chart shows, the trends of debt structure aren’t that great either:

ItaldebtfinalVariable rate   Fixed rate  

What we see confirmed here is that 70% of Italy’s debt is at around ‘7 year or shorter’ maturity, while variable rate borrowing is showing a sharp long-term decline. A large proportion of the Italian debt closer to maturity is at higher fixed rates. The yellow column is index-linked debt, a percentage that has grown ten times in ten years. This is like having a pension linked to Zimbabwean economic growth.

Indeed what all those currently ‘investing’ in Italian debt should remember is that, if Rome is the Eternal City, then debt is Italy’s eternal problem. The country has had a stability programme with bold plans and objectives since 2003. The picture overall ever since the advent of the euro in Italy is of various governments hoping that tomorrow never comes. Unfortunately, in the physical universe ruled by the illusion of time, tomorrow always comes.

The banking sector is in bad shape and riddled with mis-stated debt scandal. Non-performing bank loans (NPLs) are three times what they were six years ago…at 14% and rising. Given the still poor economic outlook, 30% of all banking firms are classified as vulnerable to a prolongation of the weak economic environment. Italy badly needs a recovery right now, but it isn’t going to happen.

It isn’t going to happen because ClubMed (and increasingly, the planet) is heading for a slump. With very high unemployment and vastly reduced pdi, consumers cannot drive a consumption recovery. The economy will probably stagnate in 2014, and it’s more than likely GDP growth will remain below 1% in 2015: don’t forget, growth during the last decade has been just 0.5% on average. Italy is suffering from structural stagnation and long-term rising debt servicing costs. Hence the term ‘basket case’.

Further, the political gearbox being in neutral means that structural reforms to improve competitiveness and productivity are highly unlikely. Arguments will continue along the usual axis of tax rises, welfare cuts and efficiency savings: but in Italy, that’s all so much hot air these days.

So forget what the yields are today, how easy is it going to be for Italy to deal with interest and maturing capital payments in the 2014-2016 period?

Italy’s outstanding bond debt stood at € 1,722,705.49 million (1.7 trillion) on the last day of 2013. In its 2014 Guidelines for public debt Management, the Italian treasury explains that ‘the redemptions of maturing securities and the coverage of the State Sector’s cash borrowing requirement are to be guaranteed through a market financing strategy’, which is of course woffle. Significantly, the guidelines talk at great length about debt issuance, but mature debt settlement doesn’t get a single mention.

Mind you, in a way it’s apposite that issuance is the key topic, because Italian bond issuance is far and away the biggest in the EU: at €260bn, it represents over a quarter of all bond issuance in the region.

The EC, of course, has an Excessive Deficit Procedure to impose on small, weak countries. It was going to do this for Italy, until Rome told them where to stick it. This might explain why, as of a week ago, the Italian government still hadn’t issued any details of plans to honour debt payments this year. However, barring some left-field event (and why bar them – they happen all the time under the globalist system) the country should get through 2014 with minimal bond maturity problems.

The tricky year is 2015. Next year, Italy will have to find €200bn in redemption payments: three times as much as Spain, and almost as much, in fact, as it will issue in debt this year. This is madness, and clearly unsustainable. As I evidenced earlier, the deadly combination of short term and fixed rate borrowing means that this size of payout is inevitable….and compared to today’s ‘market’, expensive.

Last October, Citigroup forecast that  Italy would be in near-permanent recession, with growth of 0.1pc in 2014, zero in 2015, and 0.2pc in 2016. Ambrose Evans-Pritchard observed at the time, “The debt will punch above 140pc of GDP, beyond the point of no return for a country with no economic growth or sovereign currency.” He’s written some odd columns of late, but I agree completely with his conclusion there.

So we come back to my ever-returning question here: who is buying Italian bond debt and why?

I’ve spoken to informed opinion. I’ve spoken to a Brussels source. I’ve looked at motive, and recent events…in particular, the announcement by the Italian Central Bank last November that it would be buying less Sovereign debt in 2014 versus 2013.

Something had to be done, and I believe something is being done. It involves distracting attention away from Italy’s doom, and directionalising bond markets. It involves central banks in Europe. And perhaps most important of all, it concerns the relative power in the European Union of Germany and France.

Find out more in Part Two.

Yesterday at The Slog: The Cooperative nature of the CoOp’s donations to Shadow Chancellor Ed Balls.