Could your city weather a debt crisis?

I sat in church yesterday back home in Brainerd, Minnesota, thinking about where I was supposed to have attended church that day: Rome.

Last week I was scheduled to head to Latvia to speak at the MadCity conference. I tried to balance a low cost with some premium for reliability when I booked a flight from Minneapolis/St. Paul to Riga, Latvia with a layover in Frankfurt through Condor airlines. (I booked the return trip with three separate airlines, which is cheaper but less reliable since, if the first airline fails you, they are not responsible for fixing that mess.)

Sadly, Condor failed me big time. Not only was the flight canceled with the rescheduled flight arriving well after I was scheduled to speak, but the hours I and my staff here have spent on the phone trying to get reimbursed for the ticket resulted in a promise of review in three to four weeks. I’ll just note here – and feel free to disagree if I’m being brutally unfair – that many of us look favorably on the development pattern of European cities (for good reason), but please don’t ever give me the service standards of European society. In my experience, a typical American DMV is going to give you better service than most service businesses in Europe.

So Condor failed me, but had they not, I was scheduled to spend a 26-hour layover in Rome on my way home. I had a lot of plans, including taking in a mass at St. Peter’s Basilica. I had that experience once back in 2000 and, to my astonishment, I learned a little about Italian culture when a woman in front of me answered her cell phone during mass not once, but twice. And not just answered, but had a full conversation each time. I’ve assumed I’m spending extra time in Purgatory just for having been there.

I was also interested in getting some local perspective on Italian politics and the recent gyrations in the debt market. For those of you that don’t know, Italian voters recently empowered two populist parties, the left-wing Five Star Movement and the right-wing League (formerly Northern League). In an interesting parliamentary twist – think Donald Trump partnering with Bernie Sanders – the two parties joined together to form a governing coalition.

To give you a sense of where this is headed: The Five Star Movement wants – and seems likely to get a version – a basic minimum income. The Northern League wants – and also should receive – a flat tax with lower across-the-board tax rates. Welcome to the age of populism, where you can (at least rhetorically) have your cake and eat it too.

This was all upsetting to established political operatives – again, think of the effect Trump and Sanders have on the American political establishment – but what set warning sirens off was when the coalition proposed a guy named Paolo Savona to the post of finance minister. Savona is a Euro-skeptic – think Brexit for Italy – and has spoken openly about his desire to have Italy quit the Euro and bring back the Lira.

Just like Greece before the EU started buying their debt at rates far below what the markets would suggest is wise, Italy’s interest rates started to spike as the implications of this move were considered. As the Economist explained:

During the worst days of the euro-zone debt crisis, the fear was that bond-market turmoil in places such as Greece and Spain would spread to Italy. The biggest debtor in Europe would be too big to bail out, so Grexit might lead to Italexit and the break-up of the euro. Now the attention is focused directly on Italy itself.

Contrary to many economists, the current Congress and administration, the past two administrations, the Federal Reserve, and many of you in this audience whom I hear from every time I broach this subject — I believe all this debt matters. If nothing else, Italy now does not control its own future, which is essentially what all debt does; it obligates one to future sacrifice, regardless of what else transpires in the interim.

Italy was one of the founding members of the Eurozone. They abandoned their currency, the Lira, and adopted the Euro. In doing this, they gave up the ability to (unilaterally) devalue their currency, something they had done many times since World War II.

In normal economic times (hint: we’re not in anything remotely close to normal economic times), a country that has a history of retiring its obligations by printing money (devaluation) pays a much higher rate of interest to compensate investors (think: school teacher pension fund) for that risk.

You’re not going to lend Italy money if you’re pretty sure they will devalue their currency before they pay you back. The only way they could entice lenders, then, was to pay a high rate of interest. This naturally limited how much they could borrow, something you might call market feedback.

The promise of the Eurozone was twofold. First, by going to a common currency, no single country – including Italy – could devalue the currency. This took the power of the printing press away (although, as we’ve seen in the wake of the 2008 financial crisis, the Eurozone as a whole can devalue the currency, which they have been doing aggressively).

Second, in exchange for giving up the power to devalue, countries in the Eurozone would enjoy lower interest rates. They – governments, businesses and citizens – could borrow more cheaply. Again, we can think of this as a market reaction to increased stability.

Borrowing more cheaply can bring about a couple of different reactions. First, you can save money on interest and use that savings for other things. Second, you can just borrow more for the same payment. Guess which one Italy chose.

Italy is too big to fail and too big to bail. This makes its insolvency and political instability a serious matter. Yet, there’s something about Italy that I find remarkable from a Strong Towns perspective: its cities are financially productive. Their finances and political discourse might be a mess – I don’t know – but when all that debt is defaulted on, paid off or devalued away, the typical Italian city is starting from a position of strength.

However we account for the private investment – Euros, Lira, Denarius, or something else – the public expenditure necessary to support it is going to be modestly proportional. In other words, Italy is not going anywhere. Those little Italian towns and big Italian cities are going to be here a century from now much the way they are today, much as they were a century ago. That’s what it means to be strong and resilient.

A key indicator of a country’s capacity to service their debt long term is the Debt to GDP ratio. At the end of last year, that ratio was 87 throughout the Eurozone. Italy was 132, second only to Japan among G20 members. Third in this group was the United States at 105 — the US before recent tax cuts and trillion+ dollar deficit (during an economic upswing).

You can go ahead and believe that this debt doesn’t matter, and maybe that will be the case. I personally think it will matter. But I’d be a whole lot more ready to chance it if our cities were not so financially fragile.

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