December 29, 2011

Italian debt dynamics

today I just want to leave here a small post about italian debt. I heard so many misleading comments about italian yields that I want to clarify something very clear.

The debt dinamics of an economy follow mathmatic rules, were one can show that the debt to gdp ratio falls anytime the economy grows in nominal terms faster than the growth rate of the debt, i.e., the amount of new net debt plus interest.

the important lesson here is that growth used to evaluate the evolution of the debt to gdp is the nominal gdp growth, i.e. real growth + inflation.
that's the reason one economy can monetise and escape from a debt trap by inflating. using this method will penalize all the creditors, because they will receive their money at a later moment, when that money worth less, because its value was lowered by the inflation.

so, is this 7% yield on italian bonds suatentable? is it comparable with similar yields paid by italy in the pre euro area crisis?

The answer for the second question is easy and fast: no! when italy paid 7% (oe more) in the past, during the 90's and before the euro, italy had an inflation rate of more than 5%. So, the italian nominal GDP grew every year more than 5%, only because of the effect of prices (inflation). Even a small real growth was enougth to sustain the debt to gdp at the same level.

So, now one can see that the answer for the first question is more tricky.
if italy pays 7% for its debt, italy will only be able to reduce its debt to gdp ratio (currently at aroun 120%) with nominal gdp growth larger than 7%*120% = 8.4%

but italy has primary surplus, and in the past had ability to hold on budget surplus of around 4% for many years in a row. so the nominal growth rate necessary to achieve a debt to gdp stabilization would be around 4.4%.

with inflation expected to be near, but bellow 2%, italy needs to grow more than 2% in real terms for the next years to avoid the debt trap. That's not easy! but there is still some room for hope: not all the debt italy issued pays 7%. actually, to date only a very small fraction of it is paying that amount (7% which represents about 5% in real terms!!!), so if markets start soon to revert and finance italy at lower rates, there is still hope for italy... or italy may need to adopt any kind of help to stay away from markets (like imf support) or the most probable, the use of the insurrance mechanism of the EFSF that may allow italy to finance itself at slightly lower rates. Italy may also try to roll most of its debt issuing shorter term debt, which seem to have more demand, supported by the ecb ilimited lending facilities, up to 3 years.

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December 22, 2011

December 21, 2011

Is ECB sterilizing those 489 Billion Euros?

when everyone was thinking that this liquidity facility could be a huge game changer, it seems now that ecb is sterilising all the money lended this morning.

as soon as the full amount lended was known, yields in the periphery start rising. as now banks have more money to buy... who is taking the opportunity to sell?

my main guess is that ECB is taking the opportunity to deleverage its balance sheet and started to sell. this leaves the game unchanged, althought shifts the risk back again to the banking sector.

December 14, 2011

Once Upon a Time there was a currency called euro

A century ago a gentleman argued that although there is a certain fear that a war could happen, this should not happen, because it didn't make economic sense in a globalized and interdependent world.


The costs of war would be so high for industrialized countries, so that war would not occur.

The first world war began five years later!


Any parallels with the current situation and the possible break-up of the euro zone is entirely coincidental. :)
 
Still, the man won the Nobel Peace Prize in 1933!
 
---- from wikipedia:
The Great Illusion is a book by Norman Angell, first published in Britain in 1909 under the title Europe's Optical Illusion and republished in 1910 and subsequently in various enlarged and revised editions under the title The Great Illusion.

According to John Keegan "Europe in the summer of 1914 enjoyed a peaceful productivity so dependent on international exchange and co-operation that a belief in the impossibility of a general war seemed the most conventional of wisdoms. In 1910 an analysis of prevailing economic interdependence, The Great Illusion, had become a best-seller; its author Norman Angell had demonstrated, to the satisfaction of almost all informed opinion, that the disruption of international credit inevitably to be caused by war would either deter its outbreak or bring it speedily to an end."

December 13, 2011

Once upon a time

Há um século atrás um senhor defendia que apesar de haver um certo receio que pudesse ocorrer uma guerra, isso não deveria ocorrer, porque não fazia sentido económico, num mundo globalizado e interdependente.

Os custos da guerra seriam tão elevados para os países industrializados, pelo que essa guerra não iria ocorrer.



A primeira guerra mundial começou 5 anos mais tarde!



Qualquer paralelismo com a situação actual e o possível break-up da zona euro é mera coincidência.





Ainda assim, o homem ganhou o prémio Nobel da paz em 1933!

The Great Illusion is a book by Norman Angell, first published in Britain in 1909 under the title Europe's Optical Illusion and republished in 1910 and subsequently in various enlarged and revised editions under the title The Great Illusion.

According to John Keegan "Europe in the summer of 1914 enjoyed a peaceful productivity so dependent on international exchange and co-operation that a belief in the impossibility of a general war seemed the most conventional of wisdoms. In 1910 an analysis of prevailing economic interdependence, The Great Illusion, had become a best-seller; its author Norman Angell had demonstrated, to the satisfaction of almost all informed opinion, that the disruption of international credit inevitably to be caused by war would either deter its outbreak or bring it speedily to an end."

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Must have books!!!