Think Greece Has Problems, What's Up with Italy?
The Italian debt crisis continues. Greece keep getting the headlines, but Italy's got trouble too. What is the crisis? The Italian government issues debt to fund its government programs. Those programs provide subsidies and benefits to Italian citizens today. They also promise benefits to Italian citizens in the future.
Does this sound familiar? It should. No, I'm not talking about Greece. That's just what the U.S. government has done and continues to do. It's what most governments of countries with so-called "developed" economies do. So Italy may be in the spotlight today, but most governments with developed economies who have promised current and future benefits to their citizens that cost more money than those governments actually take in tax revenues will be in the same hot seat that Italy seems to be sitting in today.
To deal with this problem, the European Central Bank is buying Italian debt, as well as Spanish debt. (Spain is sitting on the same hot seat as Italy at the moment.) The ECB buys these bonds because no one wants them - or at least wants them at a reasonable price. Because so many of these bonds have been issued, investors around the world won't pay the regular price for them. They want them at a discount. By buying at a discount, the interest rate the bond pays will be higher.
Its not that the Italian government is paying more interest. They'll keep paying whatever they committed to pay. At least that's what they say. And they'll pay back the principal amount of the bond when it comes due. Again, that's what they say.
But the people who buy and sell these bonds are skeptical. They look at Italy's government's finances and wonder whether they'll be able to pay either the interest or pay back the principal - or both. So the people who buy the bonds tell whoever is selling them that they won't pay full price. They want a discount just in case the Italian government welches on the deal some day.
The Italian government doesn't care so much about the people buying and selling the bonds they've already issued. The Italian government already got their money when they initially sold the bonds to the public. The people who buy and sell those bonds now are trading them. Traders are in the business of making money via the speculative activity of trading. So shouldn't the Italian government ignore all the jabbering about their bonds? What do they care?
Well, the problem comes in when the Italian government goes to sell new bonds. And, of course, they do that all the time because they promise current and future benefits to their citizens that are more than the revenues they take in from taxes. So they have to constantly borrow money to pay for those promised benefits. It they don't, they will have to welch on the promises they've made to their citizens. The citizens will get angry and not vote the politicians back into office - the politicians who made the promises.
So now, when the government goes to sell new bonds, they will have to offer to pay a higher rate of interest on the bonds in order to attract buyers. Otherwise, no one will buy their bonds and the government will not have the money they need to fulfill their promised benefits. Naturally, they'll offer whatever it takes to sell the bonds and worry about how they're going to come up with the money to pay the interest later.
Of course, if you followed this logic so far, you may wonder where this all ends. Won't Italy have to keep offering higher and higher interest to attract buyers? After all, by issuing higher interest paying bonds now, given that they don't have the money to provide the benefits they promised their citizens in the first place, they'll naturally wind up borrowing even more to pay the higher interest in the future. This can't go on forever, can it? No, it can't.
Because it can't, the European Central Bank is now going to buy the bonds. They will buy the bonds so that the Italian government doesn't have to keep offering higher and higher interest on the new bonds they issue - a situation that simply can't continue forever. The ECB will buy the bonds and they hope the people who trade the existing bonds will stop demanding a steeper and steeper discount on the existing bonds - the thing that drives up the interest rate. The ECB doesn't have to worry about paying for the Italian bonds because they can just print the money they need to buy the bonds.
You've just read a description of what's going on with Italian bonds. I suspect Italy will continue to offer their bonds so they can get the money they need to keep their citizens happy. And the ECB will continue to print the money they need to buy those bonds, so that the interest rate the Italian government has to pay doesn't keep getting higher and higher.
If all of this makes sense to you, you should consider a career as an economist working for some government. If it doesn't make sense, join the club.
Does this sound familiar? It should. No, I'm not talking about Greece. That's just what the U.S. government has done and continues to do. It's what most governments of countries with so-called "developed" economies do. So Italy may be in the spotlight today, but most governments with developed economies who have promised current and future benefits to their citizens that cost more money than those governments actually take in tax revenues will be in the same hot seat that Italy seems to be sitting in today.
To deal with this problem, the European Central Bank is buying Italian debt, as well as Spanish debt. (Spain is sitting on the same hot seat as Italy at the moment.) The ECB buys these bonds because no one wants them - or at least wants them at a reasonable price. Because so many of these bonds have been issued, investors around the world won't pay the regular price for them. They want them at a discount. By buying at a discount, the interest rate the bond pays will be higher.
Its not that the Italian government is paying more interest. They'll keep paying whatever they committed to pay. At least that's what they say. And they'll pay back the principal amount of the bond when it comes due. Again, that's what they say.
But the people who buy and sell these bonds are skeptical. They look at Italy's government's finances and wonder whether they'll be able to pay either the interest or pay back the principal - or both. So the people who buy the bonds tell whoever is selling them that they won't pay full price. They want a discount just in case the Italian government welches on the deal some day.
The Italian government doesn't care so much about the people buying and selling the bonds they've already issued. The Italian government already got their money when they initially sold the bonds to the public. The people who buy and sell those bonds now are trading them. Traders are in the business of making money via the speculative activity of trading. So shouldn't the Italian government ignore all the jabbering about their bonds? What do they care?
Well, the problem comes in when the Italian government goes to sell new bonds. And, of course, they do that all the time because they promise current and future benefits to their citizens that are more than the revenues they take in from taxes. So they have to constantly borrow money to pay for those promised benefits. It they don't, they will have to welch on the promises they've made to their citizens. The citizens will get angry and not vote the politicians back into office - the politicians who made the promises.
So now, when the government goes to sell new bonds, they will have to offer to pay a higher rate of interest on the bonds in order to attract buyers. Otherwise, no one will buy their bonds and the government will not have the money they need to fulfill their promised benefits. Naturally, they'll offer whatever it takes to sell the bonds and worry about how they're going to come up with the money to pay the interest later.
Of course, if you followed this logic so far, you may wonder where this all ends. Won't Italy have to keep offering higher and higher interest to attract buyers? After all, by issuing higher interest paying bonds now, given that they don't have the money to provide the benefits they promised their citizens in the first place, they'll naturally wind up borrowing even more to pay the higher interest in the future. This can't go on forever, can it? No, it can't.
Because it can't, the European Central Bank is now going to buy the bonds. They will buy the bonds so that the Italian government doesn't have to keep offering higher and higher interest on the new bonds they issue - a situation that simply can't continue forever. The ECB will buy the bonds and they hope the people who trade the existing bonds will stop demanding a steeper and steeper discount on the existing bonds - the thing that drives up the interest rate. The ECB doesn't have to worry about paying for the Italian bonds because they can just print the money they need to buy the bonds.
You've just read a description of what's going on with Italian bonds. I suspect Italy will continue to offer their bonds so they can get the money they need to keep their citizens happy. And the ECB will continue to print the money they need to buy those bonds, so that the interest rate the Italian government has to pay doesn't keep getting higher and higher.
If all of this makes sense to you, you should consider a career as an economist working for some government. If it doesn't make sense, join the club.
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