Why There Is No Real Sovereign Debt Crisis In Italy

by: Elliott Auckland

Once again we, the human race, have proven our irrational abilities of completely misunderstanding a situation, forgetting history and missing the forest for the trees. Europe is a wealthy and competitive union that will work its way through this confidence crisis.

Misunderstanding Italy

The U.S and the UK love to be smug about the Eurozone's problems - I am British myself. But neither is it true that the problems are worse in Europe than elsewhere, or that they can't and won't be solved. I think the biggest fallacy that is spread around global media is the size of debt to GDP. I do not deny that a higher debt to GDP will likely reduce the long term growth potential - as government agents are far less efficient at allocating capital than the private agent.

But the sudden thought that because Italy has 120%* debt to GDP they will go bankrupt is rather ludicrous. Why? Well, just think about it, one is only analyzing the liability side of the balance sheet. A similar claim would be that JPM will go bankrupt because it has $2 trillion in liabilities - this is not true because a) Assets are greater than liabilities and b) Cash flows are generally positive. They are both liquid and solvent.

* Is debt to GDP for Italy really an accurate measure when the shadow economy is so large? I very much doubt it.

So, is Italy solvent?

Currently on the public sector liability side Italy has an undeniably large €1.9 trillion in debt and €2 trillion on the private sector side. (=246% of GDP, vs. 325% for the US)

In direct state sellable assets Italy has €0.8 trillion, and now, prepare yourselves...The Italian private sector? Over €6 trillion (just over 5x GDP).

Is Italy liquid?

Maybe a fact that you might not have known, but Italy has had a primary budget surplus for 17 of the past 20 years. Also, similarly to Japan, domestic ownership of debt is fairly high - with 6 trillion euros in private wealth it is quite easy to finance yourself.

Forgetting history

I forgive you for not knowing Italian economic history, but we have been here before, in a far worse predicament than today and solved it. In 1982 Italian government yields were 20%. In 1992 government yields were 15% (with exactly the same debt to GDP as today). In 2012 we are getting concerned over 5.5% interest rates. A further look into these occasions will tell you the patriotic nature that the Italian population responded with and that they dealt with the crisis at the time. When I see Italian football players coming out and buying Italian debt, as small as it seems I once again see that patriotism there.

Maybe, us in the west should take a look at our own history. The UK had 250% debt to GDP in 1950, while the US a bit more manageable 120%. Yet in these two examples of many, countries post world war managed to push through their heavy debt loads and overtime reduce to more attractive levels.

Missing the forest for the trees

Maybe we could focus on February Industrial production numbers, or perhaps quarterly GDP, or maybe an ECB minister saying they are still far away from buying Spanish debt. But this would be missing the bigger picture. Over the last 2 years Europe has come a long way:

  • Every country has an official budge balance target and austerity program. (On varying scales, unlike the US where no such agreement has been passed through law)
  • European firepower for bailouts, and financial aid has been boosted to over 1 trillion euros with the ESM coming into action.
  • The ECB has conducted the most effective monetary policy in aiding the crisis: A 1 trillion Euro Long Term Refinancing Operation (LTRO).
  • Italy has brought in an economically intelligent Prime minister in Mario Monti, who has already passed major reforms that will increase competition, productivity and ultimately growth in Italy, while also decreasing the fiscal burden.
  • Italian banks have written down assets aggressively and raised capital.
  • Even international spectators are more friendly towards helping Europe.

So who do I recommend?

Well, if you can buy into Italian equities directly there is a plethora of great companies to choose from. From the US, one can buy the EWI ETF that tracks Italian indices. Personally, I like going to the heart; buying Italian banks. Simply put Italian private institutions and individuals are so asset healthy that Non Performing Loans are ultimately limited. Banks like Unicredit OTCPK:UNCFF and Intesa Sanpaolo OTCPK:IITOF are on extraordinarily cheap valuations, while having a very diverse range of operations. (For example Unicredit has a large stake in Polish bank Pekao OTC:BKPKF, which is highly successful and trading above book - thus if they were to sell it at market prices it would create a significant Basel II/III Capital gain). Perhaps a move defensive way of playing an oversold stock would be Telecom Italia TI on 6.5 times Earnings and 5% dividend.

Not only do I believe that Italy's problems are very solvable, but the steps they are taking to reform their economy will contribute greatly to their long run economic growth potential. Italy is dealing with their problems, to look away now would be to miss a great turning point for this economy.

Disclosure: I am long OTCPK:UNCFF.

Additional disclosure: I am also long Italian asset manager Banca Generali, who I have not mentioned in this article nor are they traded outside of Italy.