Italy, EMU and the Evil Eye

Italy has a primary budget surplus and low private debt. So why sell?

For those in Euroland convinced that Anglo-Saxon hedge funds and speculators are responsible for the sorry state of the Italian bond market (seemingly the view of EMU’s entire governing class), here is a nugget from a Swiss blue chip investment house.

Dieter Wemmer, CFO of Zurich Financial Services, said his group had slashed its holdings of Italian government bonds by €2bn since June 30, cutting its exposure to €6bn.

It also had €5bn of Spanish debt and €18bn of Greek debt.

Much of the capital flight from Italy is crossing into Switzerland, so the Swiss have a good insight into the behaviour of the Italian financial elites.They know what Italy’s insiders are doing.

The ZFS announcement follows a revelation by Deutsche Bank that it had cut its exposure to Italy from €8bn to €1bn by hedging (ie, buying insurance) through the CDS market.

These are not hedge funds. They are real money accounts, and they give us a glimpse into what is happening.

Italy has a primary budget surplus, the best fiscal profile of the G7, and low private debt. So why do Swiss investors want to pull out?

Why are other countries with their own sovereign currencies and central banks able to borrow at barely over 2pc for ten years despite awful public finances, while Italy had to pay 6pc until the ECB intervened this week, and still has to pay 5pc now?

I hate to keep repeating an elementary point but currency unions switch exchange rate risk into default risk. Italy’s current travails are a direct result of — and function of — EMU membership.

The deeper issue is that Italy is 20pc over-valued within EMU and is now trapped in very low growth and a stubborn current account deficit. This is a slow rot. It is directly linked to EMU membership.

Italy could have used the decade and half since Euroland’s currencies were locked together after Maastricht to free up labour markets and carry out the `micro’ reforms needed to make EMU viable. It did not do so. It is very late in the day now.

Yes, before Euroland readers all scream “what about the mess in Britain?”, let me repeat for the millionth time that I don’t write about Britain. The rest of the Daily Telegraph is giving blanket coverage to the current stew of riots, knife attacks, and anarchy in British cities.

Britain is of course in a terrible mess, but Gilt yields nevertheless fell below 2.5pc this morning. The UK is very lucky that it still has the sovereign instruments to mitigate the fiscal disaster left by Gordon Brown.

Italy has the ECB, and behind it stands Germany. Whether Germany will continue to stand behind the Project as the cost rises is the great unknown. That angst is what is really eating away at markets.

Linde chief Wolfgang Reitzle caught the mood when he said: “I am fundamentally for the euro, but not at any price — above all not at the price of socializing the debts of other countries.”

I suspect that is the true voice of Germany, whatever the German ministers may say to please peers in Brussels.