Dan O’Brien: Italy on the brink of sparking a financial disaster across Europe
WOULD you feel safe high on an icy Alpine precipice roped to Donald Trump? That is the best parallel to describe where Europe, or the eurozone to be precise, finds itself now.
The continent is having its Trump moment. This week a government is taking office in Italy whose worldview is remarkably similar to the US president’s in a number of important respects. Before looking at those similarities, consider first why everyone in Ireland and elsewhere across the continent has reason to be alarmed.
The creation of the euro was a momentous decision. It tied its members together much as a climbing party is roped up on a mountaineering expedition. When one member loses its footing all are imperilled, as was demonstrated so clearly when Greece slipped in 2010.
The eurozone survived that near-death experience, even if it was a close-run thing. It was close run despite Greece being a tiny economy. What is truly alarming about the prospect of Italy losing its footing is its sheer size. It is one of the big three economies of the 19-member single currency bloc along with Germany and France, and 10 times bigger than Greece.
The Italian economy is as weak as it is big. There has been no growth since the turn of the century and Italians are poorer on average today than in 2000. Government debt levels relative to the size of the Italian economy are similar to those of Greece when it began its slide almost a decade ago. In cash terms the Italian government owes more than any other in Europe.
The country’s banks are also in bad shape. Of all their loans to individuals and businesses, 10pc are bad. That is one of the highest proportions in Europe and far above historical norms for a developed economy. Some banks have recently failed and others could go the same way if more loans turn bad and/or a run on the system starts. The new government, if it carries out its promises, will make matters worse, not better.
I lived in Italy in the 1990s and analysed its politics and economy at the Economist Intelligence Unit for the best part of a decade. The former experience was a joy; the latter deeply depressing. It was depressing because Italy’s political system, among the most corrupt and inefficient in Europe, proved incapable of modernising itself and reforming the country’s economy.
It is for this reason Italy has been the sick man of Europe in the 21st century. Perhaps it was inevitable that, sooner or later, economic stagnation and political failure would cause Italians to choose a government that is shaping up to be more radically different than any in a major European democracy in the post-World War II era.
The similarities with Trump show just how different it promises to be. Both parties forming the coalition have a very curious infatuation with the Russian president, Vladimir Putin. Despite explicitly echoing Trump’s language – talking of an “Italy first” stance – they are prioritising a lifting of sanctions on Russia, a country with which Italy has no significant economic relationship.
They are also strongly antiimmigration and have talked about mass deportations of migrants already in the country. Yet another similarity with Trump is commitment to big tax cuts. Along with an unTrumpian ramping up of social welfare expenditure, its commitments will blow up Italy’s already fragile public finances.
That brings us to the most important similarity. Trump rejects the international order as it has existed for decades. While countries’ relative power is still central in that order, rules matter too. Trump doesn’t want to be bound by rules and agreements – from climate change to trade – preferring an unrestrained leveraging of raw American power.
The two parties forming a coalition in Italy this week reject the European order and are against some of its most important rules.
A government in the euro that is intent on ignoring the economic and fiscal rules underpinning the euro order does not have the power to make its other participants fundamentally change those rules. But it does have the power to reignite the crisis of 2010-12.
How might that happen? The Italian government and its financial system are tightly connected, with the latter owning around half of the former’s debt. If the Italian state was to default, the country’s banks would likely suffer losses big enough to collapse the financial system.
While this gets considerable attention, less focus is paid to the hundreds of billions of euro worth of IOUs that the Italian banks themselves have outstanding. These are widely dispersed across the eurozone. They would be worthless if the Italian banks collapsed.
An Italian crisis would thus spread to the rest of the eurozone via both the government bond market and the bank bond market. This is what happened with Greece, but on a much smaller scale.
If the default dominoes start to fall in Italy, there may be no way of stopping them falling across the rest of Europe. If that were to happen – and I don’t wish to sound alarmist – it would amount to the greatest financial crisis in history.
Some banks have recently failed and others could go the same way if more loans turn bad