There was much discussion yesterday about the US Treasury report that determined China was not a currency manipulator.
However, there are six countries on the manipulation watch list: China, Japan, Korea, India, Germany, and Switzerland.
- Japan, Germany, and Korea have met two of the three criteria in every Report since the April 2016 Report having material current account surpluses combined with significant bilateral trade surpluses with the United States.
- Germany has the world’s largest current account surplus in nominal dollar terms, $329 billion over the four quarters through June 2018, which represented its highest nominal level on record. Germany also maintains a sizable bilateral goods trade surplus with the United States, at $67 billion over the four quarters through June 2018. There has been essentially no progress in reducing either the massive current account surplus or the large bilateral trade imbalance with the United States in recent years, in part because domestic demand in Germany has not been sufficiently strong to facilitate external rebalancing and because Germany’s low inflation rate has contributed to a weak real effective exchange rate.
Try Fixing This
- The Euro is 11% undervalued in Germany, the largest Eurozone economy.
- The Euro is 9% overvalued in Italy, the third largest Eurozone economy.
The normal way central banks make adjustments to fix over-valued or undervalued situation is through interest rate policy or direct currency intervention.
No matter which the ECB does, it will impact Italy and Germany in opposite directions.
Meanwhile, interest rates are on the verge of spiraling out of control in Italy.
Italy vs Germany 10-Year Bond Spread
Theory vs Practice
In theory, German, Italian, and Greek 10-year bonds should all have the same yield. In practice, they clearly don’t.
The spread between German 10-year and Italian 10-year bonds is 330 basis points (3.3 percentage points).
The difference is perceived default risk. The odds of Italy leaving the Eurozone are rising.
Major Confrontation
On September 28, Italy’s proposed budget deficit of 2.4% sent bond yields soaring. And they haven’t stopped.
Today, ECB president Mario Draghi warned “Undermining EU budget rules carries high price for all” and yields surged again.
For discussion, please see Italy Bond Yields Surge In Confrontation with ECB President Mario Draghi.
Sudden Stop of Capital
Italian bonds are just two steps above Junk.
Again, this should not happen “in theory”. All Eurozone sovereign debt should have similar ratings.
Practice is another matter, as Goldman Sees Italy Junk Risk Leading to ‘Sudden Stop’ of Capital.
Capital Flight Underway
Capital flight is already underway. Proof can be found in Target2 Imbalances.
Target2 Imbalances
Italian Money Heads to Switzerland
Zerohedge reports More Italians Move Savings to Switzerland as Fears of Banking “Doom Loop” Intensify.
With the euro weakening against the Swiss franc and Italian stocks and bonds tumbling once again on reports that the European Commission is planning to reject the Italian draft budget plan submitted earlier this week – a repudiation of Italy’s populist leaders that was widely anticipated – the Telegraph’s Ambrose Evans-Pritchard offered a glimpse into how middle-class Italians are reacting to the deteriorating relationship between Italy and the EU, and its attendant impact on the country’s banks and capital markets.
In a trend that’s eerily reminiscent of the banking run that precipitated the near-collapse of the Greek banking system (most recently in 2015), Italians are scrambling to convert their euros into Swiss francs and stash them across the country’s northern border with Switzerland.
Big Players Already Out
The Swiss group Albacore Wealth Management told Italy’s Il Sole had received a wave of inquiries from Italians with €5m to €10m in liquid capital. The super-rich are already a step ahead. “The big fish have been organizing the expatriation of their wealth for some time,” it said.
“There is fear creeping in,” said Massimo Gionso, head of family wealth managers CFO Sim in Milan.
“People are concerned that if we get into the same situation as Greece, they might find the banks are closed and they can take out only €50 a day from cash machines. They don’t want to risk it,” he told the Daily Telegraph.
“These are families with savings of €200,000 or €300,000. They want to set up accounts in Lugano or Chiasso across the border in Ticino where everybody speaks Italian. The big players have already got their money out,” he said.
How Much Money Is Leaving?
- Italy July Target2 : -471.1 Billion Euros
- Italy August Target2: -492.5 Billion Euros
Between July and August, Italy’s Target2 imbalance rose by 21.4 billion euros. That was before these budget concerns became apparent.
Fatally Flawed Setup
- The ECB’s interest rate policy, was fatally flawed from inception.
- Target2 is a failed construct
- German productivity vs peripheral Eurozone productivity is yet another issue.
- EU policies take all 27 nations to agree, or nothing gets done. So the broader EU is fatally flawed as well.
These flaws were generally recognized actually. So were problems with Greece. Yet, they welcomed Greece with open arms.
The global economy is slowing, Trump’s trade polices are wreaking havoc and Brexit is going to damage trade ralations as well.
We have had a 10-year recovery, yet the ECB is still expanding its balance sheet. The ECB is supposedly going to cease those asset purchases in 2019.
Good luck with that.
Who will buy Italian bonds, and at what price? And what about the Italian bond inevitable downgrade to junk?
Good luck with that, too.
Word of Advice
If you have money in Italian banks, get it out now, while you can. Capital controls are coming and Italy is increasingly likely to leave the Eurozone entirely.
Related Articles
- Debate Over Target2 Continues: Twilight of the Euro
- Italy Bond Yields Surge In Confrontation with ECB President Mario Draghi
- US says China NOT a Currency Manipulator: 5 Countries Meet 2 of 3 Conditions
- Eurointelligence Displays Stunning Ignorance Regarding Target2
- Another Rebuttal to the Idea that Target2 Claims are “Fictional”
Mike “Mish” Shedlock
If Italy had their own Lira it would be at least 30-40% lower than the Euro and as a consequence Italians would have their competitiveness back and Italian economy would boom and less Chinese crap and less German made products would be imported to Italy.
Italy can NEVER repay their debts as long as they are in Euro but Germany and bankers do NOT want Italy to leave Euro because they are afraid they would not be paid their Euro debts if Italy did leave the Euro.
Something will break sooner or later…
Curious what awaits Italy; a fate like Greece where even extremist parties are beholden to the bankers and every tangible asset is now collateral? Greece’s sovereignty and its future has been vaporized; not a good precedent.
Italians and Greeks are mostly crooks. Corruption levels of a 3rd world country. Anyone who would loan them anything without sufficient collateral is asking to be stiffed.
ECB rule:
All Italian government debt like all government debt from countries in Euro should be considered 100% money good.
This of course led to banks chasing yield since everything was 100% money good so banks bought Italian government debt and Greek government debt since interest rates from them were higher.
When EU fails it will be because of the central planning madness EU and Euro has become…
JL1 is basically right. The EU propogated this idea that a
Greek Bond was just as good as a German Bund, which was arrant nonsense, but that effectively destroyed the risk premium.
Nothing will change until something breaks. If Germany/EU benefit from the Euro vs $ the US is powerless to do anything about it. Only decoupling of southern Europe will encourage a German currency higher.
If they were truly in it together the Germans should recycle all exchange rate benefit they achieve back to southern Europe.
It’s a hypocritical set-up.
Perahaps Californians should get their money out of CA before TSHTF?
There is no “overvalued” and “undervalued” currencies. All that is just more mumbojumbonomics by the same yahoos who believe governments and central banks are some sorts of useful entities.
If Germany’s currency was “undervalued”, Germans would be underpaid. Someone should hire them and bid up their wages. Firing overpaid Italians in the process.
In an even half rational world, everyone would be using Gold. Leaving no room for childish Mickey Mousing around with “managing exchange rates,” by the same abject nothings who haven’t gotten a thing right about anything since the day they were first born.
Germans are underpaid in Euro relative to what they would be paid in Deutchmark which makes German companies have larger profits so German elite benefits from Euro.
Italians are overpaid in Euro relative to what they would be paid in freely floating Lira which makes Italian companies shrink or go out of business so Italians suffer from Euro.
But Italian Elite has enjoyed nice debt spending spree on the backs of other Euro countries and the value of Italian elite’s bank accounts and investments and real estate is protected by them being nominated in Euro since Italy is in Euro.
In Lira the value of all would be lower.
Many would hire Italians if one could pay them in floating rate Lira since that would mean they would be cheap to hire since the value of Lira would be much lower than the value of Euro.
If one needs to hire and pay wages in Euro for both Germans and Italians it is better to hire Germans since they are more efficient…
And Argentina and Venezuela and…
Just like in Turkey and Cyprus and Greece and China….
Seems to be a pattern…
“If you have money in Italian banks, get it out now, while you can. Capital controls are coming and Italy is increasingly likely to leave the Eurozone entirely.”