16th March 2012
Since the beginning of this year there has been a considerable improvement in a measure that was previously widely used to judge the Italian economy. If we look at Italy's ten-year government bond yield it reached a peak of 7.38% in late November 2011 and then another peak of 7.17% in early January but has now fallen substantially to 4.85%. The fall in her three year bond yield has been even more spectacular as it has plummeted from 7.72% to 2.72% and if you were holding these large profits were available in a short space of time. However for the Italian government this represents a considerable improvement as it is now much cheaper for it to issue debt and its financial position is accordingly improved.
Is there a "rub" as Shakespeare put it?
The "rub" is that a false market in Italian (and other countries) debt has been created by the European Central Bank with its two large monetary operations which offered cheap (initially at 1%) three-year liquidity. Some of the over 1 trillion Euros supplied was used in what is called the Sarkozy trade where it was invested in higher yielding government debt. If you look at the high for 3 year Italian debt yields of 7.72% and you can fund it at 1% then one can see why banks would find such a trade attractive. For those who want the full details I discussed it in this article.
So this policy has helped achieve two main objectives. It has courtesy of the largess of the Euro zone taxpayer supported and improved the Italian government bond market and hence her public finances and done so via providing easy profits for Italian (and other) banks. So we have themes which are rather familiar which is that you could argue that this is a bank support operation which happens to have helped Italy! And that we have a can which has been kicked three years into the future.
In the past I have established the view that Italy has been a slow growth economy with high levels of public debt. The latest economic growth figures only reinforce that view. From Istat:
"In the fourth quarter of 2011 the seasonally and calendar adjusted, chained volume measure of Gross Domestic Product (GDP) decreased by 0.7 per cent with respect to the third quarter and by 0.4 per cent in comparison with the fourth quarter of 2010."
On a quarter on quarter basis there was a possibly ominous note to this as imports fell by 2.5% and exports were stationary. Falling imports improves GDP all other things being equal so we had a flattering influence whilst there was no sign of what is called "export led growth".
If we look back we see that in the last three quarters of 2011 Italian economic growth went -0.2%,-0.4%,-0.7%. If we look forwards we see most forecasts are now for a decline by 1 to 2% in 2012.
A "lost decade"?
We see that in the period 2002 to 2010 Italy's GDP barely rose moving as it did from 1,218,219 million Euros to 1,221,158 million using the year 2000 as a base. But if we add in that her economy had a fourth quarter in 2011 that was weaker than the same quarter in 2010 and looks as if it will shrink again in 2012 then are you thinking what I am thinking? 2012 could be weaker than 2002 in absolute terms and Italy will have had her own "lost decade" and a European economy will have mimicked at least partially Japan's experience in the 1990s.
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