Italy, democracy and the euro cage

It is not just the Italians who are trapped by the single currency

Gideon Rachman



Opera-goers streaming out of La Scala in Milan on Thursday night turned on their phones to discover that Italy finally seemed to have a new government.

The opera they had been watching, Aida, ends with the doomed lovers dying together, while locked in an underground prison. Some members of Italy’s new government might see that as an apt symbol of their country’s fate inside the European single currency. Paolo Savona, who will serve as Italy’s Europe minister, has described the euro as a “German cage”.

However, Italy’s new administration has now promised to stay inside the cage for the foreseeable future. In fact, the coalition between the League and the Five Star Movement was only accepted by Italy’s president once the europhobic Mr Savona was blocked from taking up the even more sensitive job of finance minister. In a further sign that the League is backing away from its longstanding flirtation with leaving the euro, a road sign proclaiming “Basta Euro” that stood outside the party’s headquarters was painted over last week.

For students of European politics, all this looks familiar. A populist government has once more been forced back into EU orthodoxy, by a combination of Brussels, Berlin and the markets. The only novelty is that this time it happened even before the new Italian government had sworn in.

The EU’s critics have long argued that this pattern illustrates that the bloc is, at heart, undemocratic. Mr Savona made this case in a recent book, claiming that the Italian government led by Silvio Berlusconi was brought down in 2011 by Franco-German pressure and that this was “an undemocratic act typical of the philosophy that dominates the EU’s actions”.

This argument has been made with increasing frequency in southern Europe, as the euro crisis has developed. Yanis Varoufakis, the former Greek finance minister, has likened the EU and the IMF’s pressure on the government of Cyprus in 2013 to a “coup”. In Mr Varoufakis’s mind, this was a rehearsal for the successful financial and economic pressure that was placed on Greece to reverse course after the country had voted to reject the terms of an EU bailout in 2015.

This debate over whether the EU is anti-democratic is bound to resurface in Italy. Even if the Italian government steers clear of any effort to leave the euro, it still seems likely to clash with the EU authorities over both fiscal policy and immigration. Matteo Salvini, the League’s leader and Italy’s new interior minister, has promised to speed up deportations and detentions of up to 500,000 illegal immigrants — which could cause angst in Berlin, as well as potentially violating EU law.

The League also wants a flat tax of 15 per cent on income. Five Star, its coalition partner, has argued for a universal basic income. Those policies together are a recipe for blowing up the EU’s 3 per cent limit on national budget deficits.

If the government in Rome ignores the EU’s fiscal rules, the reaction from Brussels and Berlin will be harsh. When Italy then finds itself under pressure from the bond markets, the likes of Mr Varoufakis and Mr Savona will return to the argument that the EU elite is conspiring against the will of the people.

The crude version of this argument does not make much sense. The biggest constraint on Italy’s freedom to cut taxes and boost spending is the level of the country’s debts rather than the EU’s rules. Italy’s debt stock is over 130 per cent of gross domestic product. In absolute terms, it is the third-largest in the world, after the US and Japan. Any sense that Italy is giving up on fiscal discipline — or, even more dramatically, planning to return to the lira — would probably provoke an Italian debt crisis, regardless of the statements of the EU.

But there are other aspects of euro membership that really do restrict Italy’s freedom to run its own economy. By joining the euro, Italy lost the ability to devalue its currency to restore competitiveness; or to stoke inflation to erode the value of its debts.

Some would argue that these were bad habits that Italy needed to get rid of. But after a decade of weak economic growth, many Italians look back with nostalgia to the “bad old days” of inflation and devaluation.

However, those policies could only be returned to if Italy left the euro. And any effort to do that and return to the lira is likely to provoke capital flight from Italy — and a financial crisis. In that sense, the euro is a “cage”. But the cage is inherent in the original design of the currency. The EU’s fiscal rules are merely an additional feature.

What is more, the Germans are also locked in the cage alongside the Italians. While the German economy has clearly prospered mightily, compared with the economies of much of southern Europe, Germany’s future is inextricably bound up with that of its less fortunate neighbours. A financial crisis provoked by the break-up of the euro would not be contained to southern Europe. German banks and savers would swiftly find themselves at risk. The resulting economic conflagration might well destroy not just the single currency, but the EU itself — and with it more than 50 years of German foreign policy.

At that point, the appropriate opera would not be Verdi’s Aida, but Götterdämmerung by German chancellor Angela Merkel’s favourite composer, Richard Wagner.


Will the Fed Set Off a Recession Alarm?

The Federal Reserve’s expected rate increase this week will take the yield curve one step closer to inverting

By Justin Lahart
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Federal Reserve Chairman Jerome Powell
Federal Reserve Chairman Jerome Powell Photo: aaron bernstein/Reuters 


The chairman of the Federal Reserve, just four months into his term, could be in the uncomfortable situation this week of signaling that a recession is coming.


EVERYTHING THAT RISES MUST INVERT
Yields on 10-year and 2-year Treasurys

Source: WSJ Market Date Group


The Fed seems all but certain to raise its target range on overnight rates by a quarter point for the second time this year on Wednesday. There is a good chance it ups its estimate for total rate increases for 2018 from three to four.

The Fed’s last set of projections, in March, showed that policy makers on balance expected to raise rates three times. But nearly half of them reckoned on four rate increases, and the unemployment rate has since fallen from 4.2% to 3.8%, which is where policy makers thought it would be at end the year. Inflation has gotten a bit warmer.

The difference between three and four rate increases may not matter much to investors, who expect rates to keep rising next year. But it matters a lot for the yield curve, which is edging closer toward inverting, the situation where short-term rates are higher than long-term rates.

That is a longstanding signal that a recession is coming.

The yield on the two-year Treasury, which reflects investor expectations of what overnight rates will average over the next two years, has climbed to 2.5% from 2.31%. The 10-year Treasury yield of 2.94%, on the other hand, is basically level with where it was in March. That has taken the yield curve, as measured by the difference between the 10-year and two-year Treasury yields, to just 0.4 percentage points—the smallest gap in over a decade. And it has taken it that much closer to inverting.

The yield curve last was inverted in 2007, just before the recession. It also inverted in 2000. Federal Reserve Chairman Jerome Powell, when he holds his press conference on Wednesday, may be asked to explain why a recession won’t follow if the curve inverts again.

He may answer that this time is different. Many policy makers believe the low level of long-term rates around the world now are residual effects of central bank bond-buying programs rather than rate expectations. Higher rates in the U.S. have made Treasurys attractive to foreign buyers, keeping rates low.

Further, Goldman Sachs economist Jan Hatzius points out that an inverted yield curve isn’t the cause of recessions so much as the result of the Fed trying to keep the economy from overheating. The Fed can’t hold off on rate increases it thinks are necessary just because of what the yield curve is doing. That risks falling behind and then raising rates even more aggressively later, and making the yield curve invert even more.

Mr. Powell may have a lot of explaining to do.


How Suicide Quietly Morphed Into a Public Health Crisis

By Benedict Carey
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A candlelight vigil by family members of a young man who killed himself in Salem, Ore. Medications and psychiatric treatment are more widely available than ever, yet suicides in the United States are on the rise.CreditAshley Smith/Statesman Journal, via Associated Press


The deaths of the designer Kate Spade and the chef Anthony Bourdain, both of whom committed suicide this week, were not simply pop culture tragedies. They were the latest markers of an intractable public health crisis that has been unfolding in slow motion for a generation.

Treatment for chronic depression and anxiety — often the precursors to suicide — has never been more available and more widespread. Yet the Centers for Disease Control and Prevention this week reported a steady, stubborn rise in the national suicide rate, up 25 percent since 1999.

The rates have been climbing each year across most age and ethnic groups. Suicide is now the 10th leading cause of death in the United States. Nearly 45,000 Americans killed themselves in 2016, twice the number who died by homicide.

After decades of research, effective prevention strategies are lacking. It remains difficult, perhaps impossible, to predict who will commit suicide, and the phenomenon is extremely difficult for researchers to study. 
One of the few proven interventions is unpalatable to wide swaths of the American public: reduced access to guns. The C.D.C. report found that the states where rates rose most sharply were those, like Montana and Oklahoma, where gun ownership is more common.


It is predominantly men who use guns to commit suicide, and men are much less likely to seek help than women.

The escalating suicide rate is a profound indictment of the country’s mental health system. Most people who kill themselves have identifiable psychiatric symptoms, even if they never get an official diagnosis.

The rise in suicide rates has coincided over the past two decades with a vast increase in the number of Americans given a diagnosis of depression or anxiety, and treated with medication.

The number of people taking an open-ended prescription for an antidepressant is at a historic high. More than 15 million Americans have been on the drugs for more than five years, a rate that has more than tripled since 2000. 
But if treatment is so helpful, why hasn’t its expansion halted or reversed suicide trends?


“This is the question I’ve been wrestling with: Are we somehow causing increased morbidity and mortality with our interventions?” said Dr. Thomas Insel, former director of the National Institute of Mental Health and now president of Mindstrong Health, which makes technology to monitor people with mental health problems.

“I don’t think so,” Dr. Insel continued. “I think the increase in demand for the services is so huge that the expansion of treatment thus far is simply insufficient to make a dent in what is a huge social change.”

Drug trials and other randomized studies are virtually useless for capturing measurable effects on suicide. Most drug trials explicitly exclude subjects deemed a suicide risk; even when they don’t, the studies don’t last long enough to say anything definitive about who commits suicide.

But one recent study, by Danish researchers, supported the benefits of therapeutic intervention.

Using detailed medical records, the investigators studied more than 5,500 people who had been treated for deliberate self-harm, including cutting and clear suicide attempts.

Over decades, the portion of those people who got psychotherapy at suicide clinics were about 30 percent less likely to die or commit further self-harm than those who did not.

“I personally think that it’s the quality of care that matters, not the quantity,” Dr. Insel said. “We need more access, better measures and better quality of care.”

But in this country, many of those who commit suicide have received little or no professional help. Indeed, they rarely tell anyone beforehand of their plan — when there is one. Often the act is impulsive.
According to Matthew Nock, a professor of psychology at Harvard, the wide majority of people who die by suicide “explicitly deny suicidal thoughts or intentions in their last communications before dying.”

Andrew Spade, Ms. Spade’s husband, said she had seemed fine when he’d talked to her just before her suicide. Mr. Bourdain was filming one of his clever, humorous shows in Strasbourg, France, when his body was discovered.

The rise of suicide turns a dark mirror on modern American society: its racing, fractured culture; its flimsy mental health system; and the desperation of so many individual souls, hidden behind the waves of smiling social media photos and cute emoticons.

Some experts fear that suicide is simply becoming more acceptable. “It’s a hard idea to test, but it’s possible that a cultural script may be developing among some segments of our population,” said Julie Phillips, a sociologist at Rutgers.

Prohibitions are apparently loosening in some quarters, she said. Particularly among younger people, Dr. Phillips said, “We are seeing somewhat more tolerant attitudes toward suicide.”

In surveys, younger respondents are more likely than older ones “to believe we have the right to die under certain circumstances, like incurable disease, bankruptcy, or being tired of living,” she said.

The cultural currents that deepen despair and increase the chances of suicide have long been staples of sociological debate. 
The social scientists Christopher Lasch and Robert Putnam identified postwar influences that have corroded the fabric of local everyday life — the block parties, church meetings, family barbecues and civic groups that once bound people against solitude and abandonment.


More recently, the economists Anne Case and Angus Deaton of Princeton have argued that the hollowing out of the economy and loss of middle and working class supports, like unions, have contributed to a broad increase in self-reported pain in those groups, both mental and physical.

The aggressive marketing of opioids by Purdue Pharma and others eased some of that pain — and helped create a generation of addicts, tens of thousands of whom die each year. Opioids are the third most common drugs found in the systems of suicides, after alcohol and anti-anxiety medications like Xanax, the C.D.C. reported.

A decline in marriage rates has likely played a role, as well. In her research, Dr. Phillips has found that in 2005 single middle-aged women were as much as 2.8 times more likely to kill themselves than married women, and their single male peers 3.5 times more likely than married men to do the same.

“In contrast to homicide and traffic safety and other public health issues, there’s no one accountable, no one whose job it is to prevent these deaths — no one who gets fired if these numbers go from 45,000 to 50,000,” Dr. Insel said.

“It’s shameful. We would never tolerate that in other areas of public health and medicine.”


Global Markets: A New, More Difficult Stage

The Italian bond panic is the latest in a series of upsets to challenge investors who had got used to markets insulated from risk

By Richard Barley



SPOT THE DIFFERENCE
One-day change in MSCI All-Country World Index

Source: FactSet


If last year in markets was all about strong returns, this year is about rising risks: a brewing trade war, renewed political turmoil and concerns about growth. The difference is that central-bank policy that helped insulate markets from risk is changing. Investors are increasingly looking after themselves.

Last week’s wild swings in Italian bonds are just the latest in a series of shocks that have made 2017’s smooth market ride a distant memory. Surging Treasury yields, equity-market volatility and trouble in Argentina and Turkey are all part of the same picture. These have been episodes where the moves in financial-market prices have become news themselves—something that hardly happened at all in 2017, and a sign of their sheer scale.

In financial jargon, risk premia are being repriced. In everyday terms, investors are quicker to sell and are starting to pay up for protection in an environment where central banks, whose policies have pushed them to take risk, no longer have their backs.

In 2017, the biggest one-day decline for the MSCI All-Country World index of developed- and emerging-market stocks was 1.4%, and only on two days did it fall by 1% or more. This year already the biggest drop is 2.9%, and 11 days have seen declines of more than 1%.

Meanwhile, the gap between investment-grade corporate-bond yields and yields on safer government bonds in both the U.S. and Europe has been widening steadily since early February, a further sign that investors are demanding extra compensation for taking risk.


MOVING OUT
Yield spread of investment-grade corporate bonds over government bonds

Source: ICE BofAML indexes via FactSet



The VIX index, a measure of expected U.S. stock-market volatility, has also averaged 16.7 this year, higher than any of the peaks recorded in 2017, when the full-year average was 11.1.


RISK RESET
CBOE Volatility Index

Source: WSJ Market Data




With the global economy solid and inflation rising, the days of central banks doing “whatever it takes” are in the past. The Federal Reserve is raising rates while there is no sign of the European Central Bank further loosening policy. Previously, bad news came with the silver lining of a potential policy response, but now good news brings the prospect that policy will be tightened. Higher rates for U.S. Treasurys in particular create competition for riskier bonds and stocks.

Swings in Italian bonds are the latest in a series of shocks. Photo: daniel dal zennaro/epa-efe/rex/s/EPA/Shutterstock 


The low-volatility environment made it more profitable to invest without paying for insurance against downswings in markets, notes UBS . That exaggerates the reaction to events like last week’s Italian saga or to signs that the U.S. will enter a deeper trade war with its allies and rivals.

Morgan Stanley ’s strategists call the change “the end of easy” for markets. That doesn’t spell the end of returns, as long as global growth holds up. But it will require investors to be more nimble, and, after a long period when much went right, think more carefully about what might go wrong.


The New Tech That Terrifies OPEC

U.S. shale oil drillers are boosting efficiency with giant pads and walking rigs, lowering prices to a point that could hurt exporters like Saudi Arabia.

By Spencer Jakab

A fracking operation in Midland, Texas. The Permian Basin recently passed 3.1 million barrels a day of output. Photo: James Durbin for The Wall Street Journal 


What doesn’t kill you makes you stronger.

Two years ago, it looked like Saudi Arabia was winning its fight against the U.S. shale oil industry by furiously pumping crude to drive down prices. Some drillers went bust and many more flirted with bankruptcy while oil drilling in places like West Texas and North Dakota collapsed. 

The Saudi effort backfired. Instead of killing shale it spurred a wave of innovation that transformed drilling in the U.S. into a highly efficient industrial process, dramatically lowering costs and boosting output. During the next oil bust, it will be the Saudis who have to worry. 
“High prices tend to create sloppiness in this industry because people focus only on growth,” says Doug Suttles, chief executive of shale driller Encana. “Downturns make you focus on cost because it’s the only thing you can control—the oil price is out of your hands.”

Meanwhile, something remarkable is happening. The U.S., where production was once thought to have peaked nearly 50 years ago, will become the largest oil producer on the planet by next year. 
One region alone, the prolific Permian Basin, recently passed 3.1 million barrels a day of output. Stretching from West Texas to New Mexico, it would now rank No. 4 of the 14 members of the Organization of the Petroleum Exporting Countries and may soon produce more than No. 3, Iran.

The amount of oil being pulled from the ground there is already driving global markets. But what should really frighten energy ministers in Riyadh, Tehran and Moscow is how that oil is produced. The number of drilling rigs now active in the Permian is the same as back in October 2011, yet the region is producing three times as much crude.  

Just a few years ago, a well would be drilled and then the rig would be disassembled and moved to a new location—a time- and labor-intensive process. Today it is more common for rigs to sit on giant pads, which host multiple wells and the necessary infrastructure, and for them to move on their own power to a new well yards away. These rigs drill over a wider area and increasingly are being guided by instruments developed for offshore drilling that see hundreds of feet into the rock. They inject more sand underground to break open the rocks, boosting output.

Those small gains add up. Between 2010 and 2016, the average number of drilling days per rig including transport time fell at a pace of about 8% a year in the Midland section of the Permian, while initial well production grew by 33% in just two years, according to McKinsey Energy Insights.

The efficiency and drilling intensity is clear from just one site owned by Encana. The pad in the Permian started out with 14 wells, recently had 19 more added to it and may reach 60 wells—a once unimaginable concentration.

That also may make America’s reserves last longer. Encana’s approach, which it calls “the cube,” targets different layers simultaneously, which can boost the amount that can be recovered economically by about 50%, Mr. Suttles said.

The efficiency gains mean that even an epic price decline won’t halt activity at the best fields. What’s more: The industrial scale of U.S. drilling means that companies able to write big checks and handle complex logistics are driving the market. They are less likely to feel true financial distress during the next pullback.

Producers reckon that the core of the Permian is still profitable in the high $30-to-mid-$40-a-barrel range for U.S. benchmark crude, now trading around $66 a barrel. According to the International Monetary Fund, not a single Middle Eastern OPEC country can finance its budget at Brent crude below $40 a barrel.

OPEC, a cartel out to maximize its profit, talks a lot about bringing “balance” to the oil market. The bust they helped engineer left that balancing point at a price they will find it hard to live with.


The Asset We Cannot Afford to Neglect

Kevin Watkins

Students of St Dominic Bukna Secondary school take their English test

LONDON – “An investment in knowledge pays the best interest,” wrote Benjamin Franklin. A fervent advocate for public education, and a founder of libraries, schools, and the University of Pennsylvania, Franklin viewed education as the foundation of human progress. If he were alive today, he would be horrified by the state of education in developing countries – and he would most likely be backing the International Finance Facility for Education (IFFEd) proposed by the International Commission on Financing Global Education Opportunity, led by former British Prime Minister Gordon Brown. 
In an increasingly knowledge-based global economy, quality education is more important than ever. Yet the world is facing an education crisis. Some 260 million children are not even in school. More than twice that number are in school, but learning so little that they will emerge without the basic literacy and numeracy they need to flourish. This is not only destroying the hopes of young people; it is impeding the progress of entire countries – and thus of the world.



Three years ago, world leaders committed to Sustainable Development Goal 4, which calls for the provision of inclusive and equitable quality education for all by 2030. Yet, if current trends continue, more than 800 million children will fall short of that target. Given the importance of education for virtually every meaningful indicator of development – from child survival to maternal health and poverty reduction – this failure will spill over to other SDGs.

Under-investment is at the heart of the education crisis. Failing to recognize the very high returns on offer, developing-country governments invest, on average, just 4% of national income on education. Even if they raised that share to 6%, the global financing deficit would amount to $40 billion per year, and rising, by 2020.

International development finance has a crucial role to play in narrowing the gap. The modestly good news is that, after six years of stagnation, aid to education rose in 2016. The bad news is that the share of education in overall aid has been shrinking – and too little aid goes to basic education in low-income countries.

But it is not just the poorest countries that need help. The financing shortfall also affects the 53 lower-middle-income countries (LMICs) with incomes between $1,000-$4,000. These countries – ranging from Bangladesh and Zambia to Indonesia and the Philippines – account for almost 500 million of the children who will not be learning by 2030.

Many LMICs are trapped in a financial no man’s land. As their incomes rise, they receive less of the interest-free grant aid earmarked for the poorest countries. But they are unable – or unwilling – to draw on other development finance, notably loans from the World Bank and regional development banks. These loans are provided on far more favorable terms than most LMICs could secure on world markets, thanks to the World Bank’s credit rating.

Part of the problem is that developing-country governments are not demanding finance for education. Most prioritize loans for physical capital, like transport and energy infrastructure, over human-capital investments like education. This is plain bad economics: Countries with first-world roads and bridges but fifth-rate education systems are heading nowhere fast in terms of long-term economic growth and human development.

The World Bank itself has also attached too little weight to education. Just 5% of its loan portfolio is directed to the sector – and most of that goes to a handful of wealthier middle-income countries.

To his credit, World Bank President Jim Yong Kim is now openly challenging governments that neglect investments in their citizens. He has announced the creation of an index that will rank countries on their investment in human capital. The World Bank must now work with governments to ensure that more of its $50 billion lending portfolio goes to education – and regional development banks should follow suit.

The IFFEd could help catalyze change. Specifically, it would create a new facility designed to underwrite education loans from the World Bank and regional development banks. Because the World Bank’s credit rating enables it to advance around $4 in lending for every $1 in reserves, $2 billion in guarantees could mobilize $8 billion in financing for education. The new facility would also include a grant program to subsidize a reduction in interest rates from hard-loan to affordable soft-loan terms.

Critics worry that IFFEd-sponsored loans would create unsustainable debts – but that concern is misplaced. Some developing countries, notably in Africa, are drifting toward a renewed debt crisis. Weak revenue collection, lax budgeting, and reckless borrowing in hard currency at high interest rates on sovereign bond markets have all played a role. But the policy antidote is an increase in government revenue – notably, by cracking down on tax evasion and avoidance – and measures to reduce high-interest debt.

Rejecting highly concessional education finance in the name of fiscal consolidation is the prescription for a cure that would kill hope and opportunity. It would starve education of resources and place the burden of fiscal adjustment on the backs of children on the front-line of the education crisis, undermining economic-growth prospects and fueling inequality in the process. That is exactly what happened under the International Monetary Fund’s approach to the debt crisis of the 1980s, when structural adjustment programs forced massive cuts in spending on education and health systems.

The IFFEd cannot solve the global education crisis alone. Governments need to pursue wider reforms that focus relentlessly on quality, equity, and results. But, at a time of fiscal austerity in donor countries, the IFFEd is a piece of smart financial engineering that could to stretch donor dollars further and support reform.

Money is not enough to ensure a quality education for all. But money matters, and the IFFEd initiative will help finance investments that could unlock the potential of children who have been left behind. As Franklin recognized, the returns on those investments will be enormous – as will the costs of inaction.

Kevin Watkins is the CEO of Save the Children UK.