An Italian tale of debt,deficits and derivatives is unfolding

One of the features of modern day life is that we rarely get told the truth by official bodies and even if we get some of it we rarely get all of it! Today has opened with news in this respect from Italy and it relates to a familiar topic which is the massaging of budget and debt statistics back in the late 1990s when Italy was preparing to ditch the Lira and join the Euro. From the Financial Times.

Rome was flattering its accounts by taking upfront payments from banks in order to meet the deficit targets set by the EU for joining the first wave of 11 countries that adopted the euro in 1999.
Italy had a budget deficit of 7.7 per cent in 1995. By 1998, the crucial year for approval of its euro membership, this had been reduced to 2.7 per cent, by far the largest drop among the Euro 11. In the same period tax receipts increased marginally and government spending as a proportion of GDP fell only slightly.

So as we note that the Italian deficit figures improved considerably in the late 1990s we also note that the Financial Times is pointing out that the usual factors that lead to such an improvement appear to be missing. In other words something else looks as though it contributed and just in time some derivatives contracts appeared on the scene which allowed Italy to put some of its deficit and debt off its balance sheet. It has obtained a 2012 Italian Treasury Report and analysed it to discover this.

The report does not specify the potential losses Italy faces on the restructured contracts. But three independent experts consulted by the FT calculated the losses based on market prices on June 20 and concluded the Treasury was facing a potential loss at that moment of about €8bn, a surprisingly high figure based on a notional value of €31.7bn.

This is not the first flash of insight into Italy and losses on derivative contracts as it was revealed last year that it paid JP Morgan some 2.57 billion Euros to finally settle one from 1994. But we do now have further insight into something which looks quite a can of worms as we wonder what other deals exist?

Mario Draghi

The President of the European Central Bank was involved as he was the Director General of the Italian Treasury between 1991 and 2001. It will not help sentiment that he then moved to the Vampire Squid itself Goldman Sachs which no doubt will one day be discovered to be involved in the derivative contracts. We do know that Goldman Sachs was involved with derivatives contracts in Greece which attempted (successfully at the time) to hide her true fiscal position at Euro entry although Mr.Draghi denies he had anything to do with them.

Unfortunately for Mr.Draghi the issue of hidden derivatives contracts has come up before. Regular readers will recall the case of Monte dei Paschi di Siena or MPS which was discovered to have taken out some disastrous derivatives contracts leading to a bailout being required from the Italian state. At that time Mario Draghi was the Governor of the Bank of Italy and was accordingly responsible for its supervision.

This adds perspective for the Euro area plan to make the ECB, headed of course by Mario Draghi, in charge of Euro area bank supervision.

Of Debts and Deficits

A fundamental issue underlying this situation is that Italy has a high level of public-sector indebtedness. As of April the Bank of Italy tells us that the General Government Debt amounts to 2,041 billion Euros. Thus it is now 130% of her economic output in 2012 and even worse we know that output is declining in 2013 so far.

If we move to the budget or fiscal deficit numbers we see something that was considered to be under control and if we skip back a couple of years there were projections of budget balance and maybe even a surplus. Unfortunately for Italy in fact its deficit numbers have worsened alongside its economic prospects. Whilst the Bank of Italy points out that tax revenue rose by 3.9% on a year before in April it omits to point out that budget expenditure rose by 29%! Even if we make an allowance for monthly variability it is true that each of the last three months have shown higher expenditure than in 2012 leaving the deficit numbers worse than those of 2012. So one more time it looks as though Euro area austerity involves both higher spending and higher deficits in something of a perversion of the official claims.

The Italian economy

If we look back we see that the other issue for Italy has been a lack of economic growth where even in what were considered to be good years the average growth rate was only around 1% per annum. This of course intertwined with the public-sector debt issue. The contraction caused by the credit crunch was accordingly particularly unwelcome but even worse after a brief recovery Italy’s economy turned downwards again. The latest data on this front brought more unwelcome news.

In the first quarter of 2013 the seasonally and calendar adjusted, chained volume measure of Gross Domestic Product (GDP) decreased by 0.5 per cent with respect to the fourth quarter of 2012 and by 2.3 per cent in comparison with the first quarter of 2012.

So the recovery ended in the second quarter of 2011 and has been followed by these quarterly growth rates; -0.1%,-0.7%,-1%,-0.6% -0.2%,-0.9% and now -0.5%.

Economic Prospects

Retail Sales

If we look to domestic demand in Italy the picture is as follows.

In April 2013 the seasonally adjusted retail trade index decreased by 0.1% with respect to March 2013 (-0.7% for food goods and +0.2% for non food goods). The average of the last three months compared to the previous three months decreased by 0.8%. The unadjusted index fell by 2.9% with respect to March 2012.

So no signs of a recovery and in fact a continuation of a consistent fall only broken last June. The seasonally adjusted underlying index is at 95.3 using 2010 as a base of 100.


Last week we discovered this.

With respect to the same month of the previous year the calendar adjusted industrial turnover index decreased by 7.2% (calendar working days being 20, one more than April 2012).

In April 2013 the unadjusted industrial new orders index decreased by 1.6 per cent with respect to the same month of the previous year.

As turnover numbers are boosted by inflation these again are disappointing.

Business surveys

The Purchasing Managers Index report for services had a grim headline.

Steepest decrease in new work in 2013 so far

Against this there were hopes for a recovery in Italian manufacturing so  overall the report suggests that the economy of Italy is still contracting.

Government Bond Yields

This is something which has turned against Italy. The worldwide trend to lower bond prices and higher yields has been copied here too. This began in early May when the benchmark ten-year yield fell to a 2013 low of  3.76% but this improvement ended and yields began to rise. This was added too last Wednesday as international bond yields surged and now it is at 4.84%.

Whilst this is a long way still from the peaks of above 7% as 2011 moved into 2012 a highly indebted nation like Italy can ill afford it as she has to issue new debt regularly which currently is more expensive further exacerbating future debt and deficit problems.


The underlying situation here is essentially one of public-sector deficits and debt accompanied by low and now negative economic growth. It is hard for such a story to end well! Having set a benchmark for a national debt to GDP ratio of 120% during the Greek crisis it is inconvenient to say the least for both Euro leaders and officials and Italy that its ratio is now at 130% and rising. The fall in bond yields following the announcement of the so far mythical Outright Monetary Transactions of the ECB more than offset this for a while but now yields have risen and pose questions again.

The Italian Treasury has responded to the derivatives issue already. Via Google Translate


There‘s absolutely no foundation for the hypothesis that the Italian Republic has used the derivatives at the end of the nineties to create the conditions required for the entry into the euro.

I am reminded of the words of Jim Hacker from Yes Minister which I gather may have originated with Otto Von Bismarck.

Never believe anything until it is officially denied


This entry was posted in Debt, Euro zone Crisis, GDP, General Economics, Quantitative Easing and Extraordinary Monetary Measures and tagged , , , . Bookmark the permalink.
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  • Mike from Enfield

    Hi Shaun,
    Another cracker for the lexicon there: “Rome was flattering its accounts”, meaning fraud and theft on a grand scale. Better still, ‘Rome’ did it so nobody was to blame!

  • Anonymous

    Hi Shaun,

    The malaise comes from a rotten political system where the politicians simply are not working for the Italian voters. What does a 76 year old oligarch care about a huge national debt bequeathed to Italy’s younger generations ? Given the mediaset mess and Rubygate, I’m surprised that the Italians aren’t forcefully calling for change.

    It can be done and done peacefully. In Sofia they are making their voices heard and I hope they can achieve a meaningful improvement.

  • Andy Zarse

    Hi Shaun, I seem to remember you discussing Banko MPS before and wondering if other Italian banks had other naughty derivative contracts hidden away from prying eyes…

    It might be something to keep an eye on. I have long felt the Euro Crisis will need some sort of external actor to bring about “the end”. IMO it’s likely to be a “shock” such as this, especially when combined with things such as rising Gilt yields etc that lead to ultimate Euro-meltdown…

  • pavlaki

    Shaun, Why am I not surprised? It is clear now that a number of countries fiddled their accounts so that they could join the Euro and I suspect are still fiddling them yet to avoid the truth coming out. It is why I ultimately believe the Euro is doomed. On one hand you have fiscal criteria that were conveniently achieved (and never audited by the ECB) meaning that the economic fundamentals of the Euro zone are very shaky indeed and on the other hand there is the horrendous suffering of the common folk as attempts are made to try to correct the imbalance. Something has to give. One observation I will make however, is that unlike the economic gloom that pervades Greece, Portugal, Ireland and Spain the impression I get when I visit Italy is that it is a fairly vibrant economy. The numbers don’t appear to support this but I sense that there is a difference.

  • Justathought

    Hi Shaun,

    Well, well, well… El Senior Draghi again…How clever is he, isn’t it? Involved with Greece, with Italy …Doesn’t it augur greatly for the Eurozone, does it? (Otto Von Bismarck while precursor of the modern wealth fare state, Nazi before time must probably laugh in his grave for seeing the actual state of affairs…). The Italian unfolding, another drop into this vast ocean of corruption, failed policies, lack of visions, lack of political courage, responsibilities and accountabilities…

    Western world, we have been warned since the 1970’s with the first petroleum crisis… As “democratic, free people” what have we done??? (Of course easy to attract bees with honey than vinegar… but there is no free lunch…time to pass at the till…).

  • forbin

    Hello ExpatinBG

    I get the same feeling from the British Politicos ! (not working for us )

    Its the peasant lament – if we change things they will get worse – out of the frying pan into the fire

    but it will get worse either way – corruption rots from the inside


  • James

    So, Shaun, let me get this straight:
    1. The Italians lied to get into the Euro
    2. The Greeks lied to get into the Euro
    3. The Irish bankers lied to get their bail-out
    4. No-one is allowed to vote on referendum on the EU
    5. The ECB is now run by the guy in charge of getting Italy into the Euro
    6. The banks have made tons of money over these frauds
    7. Mme Lagarde is an ex-banker now heading the IMF
    8. The new governor of the bank of England was at the vampire squid
    9. meanwhile, Cyprus is bust, youth unemplotment is at extraordinary levels in southern Europe
    And yet:
    1. No-one has gone to gaol
    2. The politicians are determined to keep the Euro at all costs.
    Something has gone badly wrong with democracy and politics…

  • Anonymous

    Hi Forbin

    The British first past the post system creates too many safe seats and disenfranchises many voters. British democracy is failing when a party with 35% of the vote can get a commons majority

    Democracy is about people power making the politicians work for the people. If the people are asleep, politicians will abuse their positions. If you want change, you’ve got to vote the crooks out or get the people out on the streets demanding change – and that hasn’t happened since the poll tax riots.

  • Rods

    The French never seem to learn as the Euro is essentially a repeat of the the 19th century LMU (Latin Monetary Union). This was setup by the French in 1865 after losing European influence due to the defeat of Napoleon and came into being in 1866 to try and gain European currency hegemony. This tied European currencies together by their different units of coinage having the same percentage of gold and silver. The initial countries were France, Belgium, Italy and Switzerland. They were later joined in 1868 by Spain and Greece and in 1869 by Romania, Bulgaria, Venezuela, Serbia and San Marino. The aim was for units of currency to have the same value, so they could be accepted in cross border trading and then converted to the same amount of a local currency.

    There were problems where there was no central controlling body which meant that each currency was run for the benefit of that country and many countries fiddled the system to a lesser or greater extent by putting less gold and silver into the coins than they were officially meant to.

    Italy was the first to do this with coins issued by the Holy See and they were recognised as debased and not accepted by French or Swiss banks and the Papal states were ejected from the union.

    This blatant cheating got so bad with one country that they were expelled. Yes, in 1908, Greece again, nothing seems to change! Although, they were readmitted in 1910!

    In 1927 the system collapsed.

    All of these flaws we can see with the Euro, with the same suspects Italy and Greece having a history of currency cheating!

    What is interesting is the length of time the system ran. With the political will behind the Euro, will it run as long until it collapses? History I think shows that economics always wins over politics. The USSR being a recent example and lets not forget Herbert Stein and his law: “If something isn’t sustainable, it won’t”

    A lesson I think I have learnt from the last few years is that a countries economic momentum and the frantic use by politicians of holed buckets as they try every trick in the book to keep the countries or countries economies from sinking is that the Euro countries and to a lesser extent all of Western Europe are going to get much poorer and indebted before the system eventually collapses.

    Another lesson is that it is very difficult for an impoverished country to claw their way back, without in demand natural resources as many East European former Communist countries have found.

  • forbin

    who woulda thunk it ;-)


  • forbin

    althought Shaun steers away from politics I would favour a voting system that accounts for those who do not vote – say a “none of the above” box !

    if that gets the majority in any constituency , then the candidates must be replaced with new candidates and the vote retaken until someone is elected

    I’d also loosen the rules for the benchmarks to be a candidates , like reducing the number of signatures needed , although being mad and a convicted criminal I ‘d keep ( although some would argue the current ones are “criminal” ! )

    its a thought


  • forbin

    Hello Rods,

    It always amazes me that no one in main stream “knows” about this little bit of history…..

    or just blatantly ignores it!


  • pavlaki

    Yes we tend to forget about that experiment although it was actually done to facilitate trade which is a better reason than the political rationale of the Euro. At least the LMU had a common foundation in the value of silver and gold without all sorts of joining criteria that can be manipulated. It was however fiddling that caused it’s downfall – which is maybe what will cause the Euro’s demise.

  • Anonymous

    Hi Mike

    It read/sounded like something done by one of the past Roman Emperors did it not? Nero might be appropriate…

  • Anonymous

    Hi Andy

    Yes I would not be surprised to discover that other Italian banks have issues in this area. However to be fair I think that such problems are widespread beyond the Italian borders and include the UK too. I simply have no faith in the accounts presented to us.

    Also as the Irish are discovering with the Anglo tapes scandal banking crises are an example of a gift which keeps on giving!

  • Anonymous

    Hi Rods

    Thanks for the history reminder and I have to confess I had a wry smile that the literal debasement was started in the name of the Holy See! Times may change but this principle seems something of a constant as I note that the new Pope has launched an enquiry into the Vatican Bank tonight…..

  • Anonymous

    Hi James

    I can add one other which is that there are now also allegations that the French used the pension fund of France Telecom to help manipulate its numbers too for Euro entry. Will it soon be everyone?

    Also I am again reminded of that great quote from Matt Taibbi in 2009 one more time.

    “The first thing you need to know about Goldman Sachs is that it’s everywhere. The world’s most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.”

    Yet as you say no-one is apparently ever responsible.

  • Andy Zarse

    Some gift!

  • Anonymous

    As I read it(?) having fixed Italy’s entry with derivatives, the guy concerned moved to Goldman Sachs where he
    similarly fixed Greece’s entry. It is hard to resist the idea that the euro was just seen as a new way to fudge access to long term credit lines by politicians.

  • Anonymous

    Italy still seems to have quite more viable exports more than Portugal and considerably more than Greece. My supermarket is stuffed with Italian foods for example.

  • Anonymous

    ….or maybe like a fish it rots from the head