The Incomplete Currency. Marcello Minenna

and can be explained by the synchronous contribution of an easy monetary stance (especially in 2008–2009) and the recognition of US Treasury Bills as a safe haven (2011–2012), worthy of being bought even at a zero nominal rate.

      The German case follows a different pattern. In fact, the negative real interest rates experienced in Germany not only in the short term but also in the medium/long term cannot be explained by a policy of financial repression but by a prevalent safe haven effect, for which German government bonds have become the safest perceived investment (see also § 3).

      Let's spend some more words about financial repression. We said that this policy requires to keep nominal interest rates constant while letting the price level grow. The intended effect on the cost of debt servicing is to reduce its sensitivity to the inflation. Accordingly, also the evolution of the Debt/GDP ratio benefits more of high inflation rates; in fact in the case of an ongoing financial repression, the growth of prices has a limited impact on the interest burden, hence allowing the government to reduce the Debt/GDP ratio or to increase debt but in a way that does not increase its relative size with respect to the GDP.

Figures 1.16, 1.17, 1.18, 1.19, 1.20, 1.21, 1.22 and 1.23 compare the evolution of the Debt /GDP ratio with the pattern of the inflation in selected countries (Argentina, France, Germany, Greece, Italy, Spain, UK and US) in a historical perspective.

Figure 1.16 Inflation and Debt/GDP ratio in Argentina (1884–2010)

      Source: IMF–Financial Affairs and Reinhart and Rogoff Database

Figure 1.17 Inflation and Debt/GDP ratio in France (1880–2010)

      Source: IMF–Financial Affairs and Reinhart and Rogoff Database

Figure 1.18 Inflation and Debt/GDP ratio in Germany (1880–2010)

      Source: IMF–Financial Affairs and Reinhart and Rogoff Database

Figure 1.19 Inflation and Debt/GDP ratio in Greece (1884–2010)

      Source: IMF–Financial Affairs and Reinhart and Rogoff Database

Figure 1.20 Inflation and Debt/GDP ratio in Italy (1860–2010)

      Source: IMF–Financial Affairs and Reinhart and Rogoff Database

Figure 1.21 Inflation and Debt/GDP ratio in Spain (1880–2010)

      Source: IMF–Financial Affairs and Reinhart and Rogoff Database

Figure 1.22 Inflation and Debt/GDP ratio in UK (1880–2010)

      Source: IMF–Financial Affairs and Reinhart and Rogoff Database

Figure 1.23 Inflation and Debt/GDP ratio in the US (1860–2010)

      Source: IMF–Financial Affairs and Reinhart and Rogoff Database

      The common trait to all these charts is the inverse relationship between the Debt/GDP ratio and the price growth. This phenomenon is particularly evident after the two World Wars, where inflation has been used as a tool to absorb the huge public debt generated by military expenses. The 70s are another significant period due to the energy crisis and the forced reduction of oil usage. The concept that eventually emerges is that inflation can be manipulated to manage debt in periods of crisis.

1.3 Single Curve of Interest Rate: EURIBOR, Euro Swap, Eurepo

      A single currency area represents an extension of the territory where the economic agents regulate their financial transactions through a shared currency having legal tender. Generally this area coincides with the territory of a sovereign state, whose government is able to forcibly impose the use of this medium of exchange (the “forced circulation”), and has sovereignty over the issuance of new currency.

      In a monetary system, it is quite natural that within the currency area there can be no subject less risky than the state itself: in fact, if a state is destined to default on its debt, it is probable that any company or bank belonging to the nation will equally be in trouble. In addition, a state can always decide to repay a debt issuing new currency, which must be accepted in every case by the counterparty.

      Consequently, the set of interest rates (the “single curve”) referred to the government of a sovereign state is the benchmark for the entire economic system of the nation. This implies that the interest rates paid by the government can be considered as “risk-free” interest rates (even if they are not) because it is not possible to invest their savings in anything less risky. Not even foreign business: for example, the United States may be perceived as a healthier state than Mexico, but for a Mexican citizen to invest in American government bonds means taking the risk of the exchange rate between the dollar and the peso, therefore for this subject, the low-risk investment remains a bond issued by the Mexican government.

      The Euro currency area is the exception to the rule.

      1.3.1 A Single Curve for All Government Bonds of the Euro Area Countries

      The nations that have joined the Euro have exclusively surrendered their monetary sovereignty to the European Central Bank, while keeping all the other typical functions of any sovereign state, including the ability to borrow by issuing public debt securities. This fact is central in understanding the functioning of the Euro and its structural problems.

      If the Eurozone does not have a federal government like that of the United States that can issue sovereign bonds, how is it possible to identify which investment is risk-free and therefore the single curve of interest rates?

Until 2007, when the effects of the international financial crisis from the United States to Europe started to unfold, the solution to the dilemma was guaranteed by the substantial convergence of the sovereign yield curves of all Eurozone countries. In essence, the risk perceived by the market operators was substantially the same for any government bonds considered: Italian, German, Greek etc. Same perceived risk, same return: the different curves of the various countries were practically indistinguishable from each other, realising in practice a single interest rate curve (see Figure 1.24).