The euro zone contagion has arrived in Italy with alarming speed.
Just as markets rose in celebration of Greece's latest financial lifeline, this week investors entered full panic mode over Italy. In recent days, its stock market has plunged, and the government's borrowing costs have risen to record highs. Italy's pain has affected the entire euro zone, with the common currency sinking to a recent low.
If Italy were to go the way of Greece, the repercussions would be enormous. Italy is the euro zone's third biggest economy. It's also the zone's biggest borrower, and the world's third most indebted nation, with government debt of $2.45 trillion — a truly mammoth sum.
Italy is literally too big to fail.
But are investors over-reacting? Italy clearly is not Greece. Sure, it has a lot of debt, its economy is sluggish right now, and its prime minister, Silvio Berlusconi, is distracted by a trial over allegations he had sex with a minor (which he denies). Yet this is a major economy with a healthy export sector and an unemployment rate lower than the United States. Its budget deficits are predicted to be only about 4 percent of GDP, less than half the rate in the United States.
Can it work its problems out on its own, or will it be the latest country in need of a bailout from the European Union?
To put the news in perspective, GlobalPost spoke with Dr. Mark Weisbrot, co-director of the left-leaning Center for Economic and Policy Research (CEPR) in Washington DC. Having accurately predicted, in 2002, that a housing bubble would cause a financial meltdown, CEPR has become a key alternative voice on economics, and a widely-quoted resource for journalists. (The interview has been edited and condensed by GlobalPost.)
GlobalPost: Italy’s government has $2.45 trillion dollars in debt, an amount equal to 120 percent of its Gross Domestic Product (GDP). That’s significantly higher than the U.S. Government's debt, relative to the size of Italy’s economy. In dollar terms, it’s more than Greece, Portugal, Spain, and Ireland combined. Yet you're optimistic that it can pay its creditors back. Why?
Mark Weisbrot: The debt to GDP ratio is not the sole determining factor of whether a debt burden is sustainable. Japan has a debt to GDP ratio of 220 percent of GDP, and nobody is worried about them. In fact, they're paying interest rates of just over 1 percent on their 10-year bonds.
You want to look at other indicators too, like what is the interest burden on the debt. In Japan's case, it's still pretty low, because half of that debt is owed to itself, to the central bank, so that interest goes straight back to the Japanese government.
The interest rate on Italy’s 10-year government bonds has increased about one percentage point over the last year. It's gone from about 4.7 percent to a high of just over 6 percent, before dropping to about 5.5 on Wednesday. How much difference does that make? Well, it's significant, but it's not huge.
Over the next two years they will roll over about a quarter of their debt. If the current interest rate holds, that extra percentage point will add maybe a half percent of GDP, which is not trivial, but it's not going to break them either.
I think the market reaction is exaggerated.
German Chancellor Angela Merkel is encouraging Italian President Silvio Berlusconi to pass an austerity budget. Will that help Italy?
Weisbrot: I think austerity does not help in a time when the economy is weak, and the Italian economy is pretty weak right now. I would want to be very careful not to fall into the trap that Greece did, taking austerity measures that made the economy shrink more.
Why have the markets panicked so suddenly over Italy?
Weisbrot: It's tough to say, but it appears to be the contagion effect. A few days ago, investors learned that the European authorities were likely to accept some kind of default on Greek debt. That caused a fear in the financial markets for some of the other countries, including Portugal, Spain, Ireland, and now Italy. In other words, all of their interest rates went up, because of a fear that a Greek default would lower the credit worthiness of these countries.
You’ve criticized the euro zone as a “right-wing project.” Can you explain that? Whose agenda does the Euro support, and how are these goals achieved?
Weisbrot: The euro zone’s central bank is a very right-wing institution. It’s far to the right of the Fed, the United States’ central bank.
For example, the European Central Bank doesn’t have a mandate to take employment into consideration when making interest rate decisions. They're only supposed to focus on inflation. In deciding interest rate policy, there's always some trade-off between unemployment and inflation. In all countries there's a conflict between labor and the financial sector. The latter does not care about unemployment. You can see this regularly in the business press: if the unemployment rate looks like it's rising, then bonds rise in value.
If we leave monetary policy in the hands of the bond holders and the creditors, there’s a strong bias toward a slow growing economy, high unemployment, and lower wages. That is the prejudice of most central bankers, but the degree really matters.
How exactly does that compare to the Fed?
Weisbrot: You have the same prejudice in the Federal Reserve, but it’s not as extreme. Fed Chairman Ben Bernanke, who's a Republican, responded to the recent recession by reducing interest rates to zero. He also adopted quantitative easing — creating money in order to stimulate the economy by driving down long-term interest rates. That is what a central banker should do when the economy is weak and unemployment is over 9 percent, as it is in the U.S.
The European Central Bank has been much less willing to use its power to stimulate the euro zone economy, even though unemployment is 21 percent in Spain, and 16 percent in Greece. Together with the other European authorities and the International Monetary Fund, they have been pushing the euro zone economies deeper into recession.
All of this is irrational, and is really based on a right-wing ideology that says, “we need to cut spending, force these governments into line, reduce the welfare state, and reduce labor protections.” Those are some of the conditions European officials are putting on the loans to indebted countries. [They believe] that somehow, these economies will emerge from the ashes better than they were before the crisis.
When you say “right-wing project,” you're talking specifically about representing the interests of the wealthy, the financial sector, and people who have money to invest?
Weisbrot: Yes, and the creditors, and really disregarding the interests of the vast majority of people. To me, that's the essence of right-wing policy.
Taken as a whole, how does this right-wing policy affect the economy?
Weisbrot: It's terribly damaging. Look at Greece. Their economy shrank 4.5 percent last year. It's going to shrink something similar this year, they're going to lay off another 20 percent of the federal labor force. They're cutting wages and pensions. This is something that's really going to harm a whole generation, and cause permanent damage.
You mentioned labor market reform. What specifically do they want to do, and what will the impact be?
Weisbrot: They want to make it easier for employers to fire people. In most of Europe, it's more difficult to fire people than it is in the U.S. In the U.S., you don't have to show cause, or pay severance unless it's in a union contract, which is a very small percentage of the labor force here. In Europe, you have a lot of laws that protect workers. They want to eliminate those as much as they can, in order to make it easier to fire workers.
Don't laws that protect workers from being fired also make employers more reluctant to hire people? It's been easy in the U.S. to hire and fire people, and yet the U.S. has a more dynamic labor market and traditionally a higher level of employment than Europe.
Weisbrot: Well, it depends on what part of Europe you're looking at. Our unemployment rate right now in 9.2 percent, and you have economies in Europe with much lower unemployment than that. There's a lot of research on this. CEPR has actually done some of it. The OECD, which is a conservative institution as well, has also acknowledged that there's no evidence that these laws that protect workers in Europe actually reduce employment.
Do you agree with Germany, that Greece's creditors should share the pain of the bailout?
Weisbrot: Of course they should. Why should only the [taxpayers] have to suffer for the mistakes of their governments? Lenders know what the risks are. That's capitalism. Some loans turn out to be bad loans. Why should we create socialism for the creditors, and capitalism and markets for everyone else?
How would you score the IMF's role in the euro bailout?
Weisbrot: The IMF is playing its traditional role of applying the medieval medicine of bleeding the patient. They did in the Asian financial crisis, and in Argentina, Brazil, Russia, and all these other middle income countries in the late 90's and early 2000's, and that’s part of a much longer history of applying this policy.
The unusual thing here is that they're doing it to high income European countries. In fairness, it isn't really the IMF making these decisions, it's the European authorities, and the United States is going along with them. Together, Europe and the United States control the IMF, and they make these decisions.
On Thursday, July 14th, Italy will need to sell bonds to keep its government running and its creditors paid. What do you predict will happen?
Weisbrot: They'll sell them, and the interest rate — well, if I could predict that exactly right now, I'd be very rich. Obviously I can't tell you exactly what interest rate they're going to pay, but I don't anticipate that this is a turning point necessarily. It's not going to blow up that fast, and I don't think the markets are acting rationally right now with regard to Italy, because they're a long way from reaching the situation that Greece is in, where their debt becomes un-payable.
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