Let's go back to discussing the work by Mediobanca Securities entitled "Re-denomination risk down as time goes by" by researchers from the house and by Marcello Minenna, a Consob official well known because for a few days he held the position of Councilor for the budget of Rome in the Giunta Raggi. We do this because, also thanks to the undoubted prestige of the Mediobanca brand, the work circulates in international political and financial circles and, as we demonstrate in this policy brief, is spreading concepts, based on wrong analyses, which can lead to considerable errors of assessment regarding the prospect of Italy leaving the euro.
The thesis is that in the event of an exit, Italy could redenominate the securities issued before 2013 in the new currency because those issued after that date contain the Collective Action Clause envisaged by the Fiscal Compact agreement which, according to the authors, would make it legally unsustainable the renaming. Again according to the authors, taking into account the outstanding stocks of the two types of securities as well as the mark-to-market value of the derivatives, and assuming a 30% devaluation of the lira, Italy's public debt would be burdened with a further burden equal 280 billion relating to new securities which would remain in euro; this burden would be partially compensated by a 'gain' of 191 billion relating to the old securities which would be redenominated in the new currency.
Under the further assumption that our partners accept a substantial cut in Italy's debts to the ECB, the authors conclude that at the moment Italy would have a small gain from the exit (8 billion). However, it would be necessary to hurry because over time this advantage would decrease (hence the title of the job).
Here are our critical observations:
1. The accounting is wrong. It is quite clear that the Italian State would not make any profit on the bonds redenominated in the new currency. It would avoid an increase in debt, such as that which occurs instead on post-2013 securities which remain in euros, but would not make any gains. A gain could only be made on any euro assets held by the state, certainly not on liability items. This means that the debt/GDP ratio must necessarily increase following the devaluation. In particular, it is easy to calculate that, with the authors' hypotheses regarding the stocks of the two types of securities in circulation, the debt/GDP ratio would register a leap from the current value of 133% to 160%.
2. It is consequently false that by leaving the euro today there could be even a small net advantage for the state.
3. The legal analysis underlying the calculations is wrong. Having heard from some of the leading legal experts in the sector, we would like to state that the relevant distinction for the purposes of the (theoretical) possibility of redenomination is not that between securities with or without CAC, but that between securities issued under national and foreign legislation. However, almost all of our public debt securities have been issued and continue to be issued under national legislation. A sovereign state can always change the rules of titles that are subject to its legislative power. There could be appeals by savers against the Italian Republic, but before Italian courts and this applies in the same way to the two categories of securities. Even on pre-2013 securities, the State would fail to fulfill a contractual commitment, that of paying a given amount of euros on maturity, not lire or other currencies. Therefore, the litigation would be substantially the same in the two cases and the Italian judges would be required to apply the Italian laws. Only very few securities (about 9 billion) are subject to foreign legislation, that of Germany and that of the state of New York.
4. Consequently, the conclusion on which the title of the work is based is not true: in reality, with the passage of time, the probability of renaming does not change at all.
5. Legal analysis of derivatives is wrong. Derivatives are also subject to Italian law and could in principle be redenominated. It is therefore not fair to say that a loss equal to their current mark-to-market value of 37 billion euro would crystallize on derivatives.
6. As Alfredo Macchiati has already observed on this issue, it is not clear how we can justify the hypothesis that the ECB allows us to redenominate 50% of the securities in the portfolio.
7. The economic analysis of the costs and benefits of redenomination, which is the crucial issue, is completely missing. If the State does not redenominate the bonds, the debt/GDP ratio jumps to 190% (again assuming a 30% devaluation). But the redenomination would be considered as a real default by the rating agencies and, more importantly, by the markets. This is a very serious problem because following the renaming the debt problem would not be solved at all: the debt/GDP ratio would in fact remain at its current level (133%). Therefore the State would continue to need to finance itself for the current very significant amounts (440 billion in 2017). But obviously following a default that would not improve debt sustainability, the auctions would be deserted and the bonds would have to be purchased entirely by the central bank. This would involve the introduction of enormous quantities of new monetary base into the system, with inevitable consequences on inflation. This cost/benefit calculation should be done before any decision to leave and should induce caution in those who propose the exit as a saving or at least reasonable solution.
8. Also missing is even the slightest mention of the costs/benefits account of the exit in general. The paper gives the impression that such an account may be limited to holding gains/losses on government liabilities. This is an extremely deceptive message. A problem similar to that of the public debt arises for private debts towards foreign countries which are as much as 163% of GDP. Banks, businesses and even individuals may find themselves having liabilities denominated in euros and assets or income denominated in the new currency. How do you avoid chain failures of banks and companies? How can we avoid a repetition on a much larger scale of the social problem we experienced in 1992 when many families had taken out mortgages in ECU whose cost became prohibitive following the devaluation of the lira? Devaluation may have a positive effect on exports, but what about the purchasing power of wages?
9. Above all, even a small reference is missing to what is the main problem of the exit, the trap of expectations. From the moment the intention to quit is made public until the moment the preparations for the changeover are completed, many months pass. How do you prevent people from emptying their banks and taking all their money abroad in the meantime? How can all this lead to the collapse of production and the decimation of savers be avoided? These are the relevant questions that need to be asked.
If the problems mentioned in the previous points are not addressed, it makes no sense to draw any conclusions on the probability that Italy will leave the euro and on the consequent risk of redenomination. Our assessment is that the current Italian ruling classes are well aware of the fact that those questions have no answers. They therefore have no intention of setting in motion a mechanism that would lead us out of the euro, via an infernal path. We do not know what would happen in the unlikely event that populist anti-euro parties win the general election. As for the work of Mediobanca Securities, as economists, we can only express a certain bewilderment, together with the hope that the authors will review their positions in the light of the criticisms that have been formulated from various quarters.
