Thursday, December 15, 2011

When All Roads Lead To Rome

This article of mine was published in Hindu Business Line print edition on December 8 (link). Has been some time wherein I wrote an article just for this blog so planning to write an article next for this blog in which I would continue my option pricing series.
Here is the article...........

Italy is among the richest countries in the world, a member of G7; among the top 10 largest economies; the population in northern parts of Italy is among the wealthiest by per capita; home to some of the top manufacturing brands and a gold reserve which is second only to Germany in the Euro region (valued at around 400 billion dollars). However now with each passing day the Italian economy is pushed deeper into to the abyss, a nation stripped off its democratic virtues; people burdened with taxes; a government saddled with debt and a nation with uncertain fate.

It’s indeed a real travesty that a nation with so many resources at its disposal is looking at a bleak future with no daylight in sight and one wonders why it is so?

Well a look at this chart can answer a lot of these questions. This graph maps the industrial production of Germany and Italy since 1993. Notice how much abreast the industrial production of these two countries used to move before the introduction of Euro in 1999. However since that time this gap has been widening and today with industrial production of Italy sagging while that of Germany rising, this gap has widened to historical levels!!!
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The ills of this Italian economic catastrophe lie in none other than this common currency “The Euro” which is destined to create disparity instead of parity among nations

A currency may be a store of value for an individual but for a society at large it is nothing but a way to transfer wealth and so an increase or decrease in the currency supply doesn't actually change the overall wealth of the society; it simply moves it from one person to the other. Remember a currency is nothing but a short term government liability and so a currency note printed by the Central Bank and given to banks increases the assets of the banks but at the same time increases the liabilities of the government by an equal amount, so net impact on global wealth is “zero”. However this increase in government liability now has to be serviced by ordinary citizens; they end up doing this by either putting in more hours than usual at work for the same pay or giving away more from their existing share of their income to the government in form of taxes.

Central banks already have monopoly over money creation and thus can easily transfer wealth these days by creating more money (to the benefit of capital owners and debtors over labours and savers) or by reducing its supply (to the benefit of labours and savers)

By giving away the power to print money this transfer of wealth is now happening not just between individuals but also between countries in Europe. Euro on a consolidated basis is a weaker currency for Germany and a much stronger currency for Italy in other words there are too few euros for Italy and too many for Germany.

So with such a strong currency there is little incentive for the capitalists in Italy to setup industries thus reducing the country’s productivity and industrial growth (as seen in the graph). Consequently the government ends up picking up the slack (over 50% is government contribution to Italian GDP) by running exorbitant debt that now it cannot repay. Such a condition is advantageous for a country like Germany; this is not to say that Germany and German workers are not good at their work but this provides an even extra edge as with reduced competition from Italian industries it ends up selling lots of its products. A look at the graph below would tell you the story.

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Had Italy been able to use its Lira it would certainly have devalued its currency by printing more money and thereby transferring some of the wealth from its labour to its capital holders, thus unleashing the country’s entrepreneurial spirit and giving an incentive for more people to start industries.

The fiat monopolised currency system existing today in any case is flawed and on the top of that a common currency area is structurally and economically wrong and as we are seeing today has disastrous consequences. By giving away the right to the printing presses not only have the Italians and other European countries given away their economic fates to foreign masters but have also as we are seeing today, possibly given away their democratic ethos. Not only is it unfair for the common Italian citizens to pay for the folly of the bankers but living under this flawed economic structure, they are also paying for the misjudgments and hubris of their politicians and economic elites. It’s time for Italy to exit this common currency experiment and in the process pave the path for others to follow.

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