Dan O’Brien: Italy on the brink of spark­ing a fi­nan­cial dis­as­ter across Eu­rope

Irish Independent - - News - Dan O’Brien

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

Giuseppe Conte, who has been given a for­mal man­date to be­come Italy’s next prime min­is­ter, ad­dresses the me­dia in Rome yes­ter­day. Photo: Getty

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