Italy’s Lira Ancestry

July 12, 2011

Before it became one of the eleven charter members of the European Common Currency at end-1998, Italy’s currency was the lira, and it performed very poorly from 1971 to 1996.  After the dollar devalued in December 1971, the lira was one of six European currencies to form the EEC snake in April 1972, an arrangement binding those currencies even more tightly together than their collective permissible movement against the dollar.  Around the time of the dollar’s second devaluation in February 1973, Italy adopted a dual exchange rate that attempted to segregate speculative transactions from others and thus take some pressure off a currency that was vulnerable because of relatively high Italian inflation rate.  This two-tiered lira was discarded in March 1974.

When my career as currency market watcher began in March 1975, the D-mark’s lira cross was at 270, already 18.5% below its average level in 1973 when floating dollar rates began.  Italian authorities abandoned intervention in early 1976 when their reserves became undesirably low.  The inflation gap by then between Italy and Germany had become very wide.  German consumer prices rose 4.2% per per annum between end-1973 and end-1978 compared to a 16.9% per annum pace of Italian inflation.  Price strains promoted lira depreciation which in turn fed domestic inflation in a vicious circle of mutually reinforcing inflation and depreciation in Italy’s highly wage-indexed economy.  The mark advanced over 25% from a 4Q75 average value of 262 lire to a 2Q76 mean of 337 lire per DEM.  In the first quarter of 1979 when eight countries including Italy formed the European Monetary System, another attempt to constrain their movement against one another, a German mark could buy slightly more than 450 lire.  The lira had lost 40% of its D-mark value in just four years.

But trouble didn’t stop with Italy’s entrance into the EMS.  It’s central parity against the mark devalued by 2% in September 1979, 6% in March 1981, 8.5% in October 1981, 7% in June 1982, 8% in March 1983, another 8% in July 1985, 3% in April 1986, and 3% in January 1987.  In the summer of 1992, Italy’s currency was engulfed in the same currency crisis that would force sterling to abandon the EMS on September 16.  In fact, pressure on the lira slightly pre-dated the run on the pound.  The lira devalued 3.5% on September 13 while the mark and others revalued 3.5 at the same time, a total downward adjustment for Italy of 7%.  The new parity against the mark was 802.5, but speculation didn’t stop there, and Italy withdrew from the EMS a day after Britain. 

In order to secure a spot with the other ten charter members to use the euro, Italy had to be readmitted into the EMS, which happened in November 1996 at a parity against the mark of 1000.  The lira had dropped against the mark about 20% since leaving the EMS in September 1992, about 55% since the start of the EMS in March 1979 and 73% or roughly 7% per annum since I’d started monitoring its value back in March 1975. 

Lira depreciation against Germany’s currency, first the mark and later their shared euro, effectively ended in November 1996, almost 15 years ago.  The hope failed that a common currency would force economic trends among members to converge, and an awful lot of time has passed without an exchange rate adjustment to enable Italy to recoup eroded confidence.  Pent-up pressure didn’t surface in the exchange market.  The lira was gone, and it’s not possible to buy the German portion of the euro against the lira component.  Inflation differentials did narrow and therefore did not send out strong alarms for a needed adjustment.  Economic growth is where Italy really suffered by not having its own currency to manage.  Italian real GDP grew just 0.6% per annum over the first dozen years of using the euro.  

Now Italy’s higher bond yields are sounding a code red.  As the third largest member of the common currency area, the adverse ramifications of  debt bailout dwarf anything so far experienced.  Leaving EMU is not an option.  For openers, the ECB would out a leader.  President-select Mario Draghi couldn’t assume that office if Italy isn’t part of the fold.  This is a big reason many people hesitated to appoint him in spite of his impeccable credentials.

Copyright Larry Greenberg 2011.  All rights reserved.  No secondary distribution without express permission.

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