How the Italian referendum next month could surprise everyone

Let's take a wee break from Donald Trump today. I think we've all earned it.

However, I can't promise you a break from politics. If last night's Question Time (on which our very own Merryn Somerset Webb appeared you can catch up with it on the BBC iPlayer if you missed it) is any measure, then the political atmosphere isn't getting any less fraught.

So I think now's a good time to take a little look ahead to the next big political "event" looming on the horizon.

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This time it's Italy the third-most important country in the eurozone in the firing line

Italy's throwing a referendum party too

On 4 December, Italy is holding a referendum.

It's not a referendum on the euro neither on the surface, nor implicitly, as we'll get to in a moment. But lots of people are worried about the outcome, and what it might say for politics across the globe in the wake of Brexit and Trump.

The referendum is meant to reform Italy's political system. Without going into the details (which are boring to anyone not intimately involved in Italian politics), the idea is to make changes that would make it easier to form stable governments and pass laws in the country.

To be clear, the changes seem reasonably sensible to an outside observer this isn't an attempted coup or creeping authoritarianism, it's an effort to have a semblance of someone being in charge and getting the odd thing done.

However, Italian citizens are fed up and irritated like many around the globe, and it looks like they'll vote against the changes, to give the people in charge a bloody nose as much as anything else.Italy's populist party the Five Star Movement is becoming more popular, and as Ambrose Evans-Pritchard notes in The Daily Telegraph, "The last 32 polls all point to defeat".

Italy's prime minister, Matteo Renzi, has said that he'll quit if he loses the referendum. But as one expert quoted by The Guardian points out, the Italian people are hardly intimidated by the prospect of political chaos.

So if Renzi loses, what happens next?

Life's easier when you have a flexible currency regime

Italy is in trouble, no doubt about it. The country has loads of structural economic problems, most of which are unlikely to change, because the Italians basically seem to like it that way (or at least put up with it).

But one thing has made their plight much worse for the past few decades: the country has endured extraordinarily sclerotic growth, even by the standards of the eurozone. And as Christopher Granville of Trusted Sources pointed out at a City seminar I went to last month, the driver of this sclerosis has been the euro, and before that European Monetary Union.

Productivity collapsed in 1996, when the value of the lira was fixed against the deutschemark. Basically, Italy's main way to compete with the likes of Germany has always been to allow its currency to devalue, making the whole country cheaper without slashing wages in nominal terms, or cutting thousands of jobs.

Devaluation is not a magic wand. However, it is an extremely useful way for countries to find relative values to one another that help an individual economy to play to its strengths, and to offset its weaknesses.

If you can't revalue your currency, then you have to embark on structural change. That is time consuming. It's politically unpopular. It involves going against years, decades, maybe even centuries of ingrained value systems and people's priorities.

Change and evolution are often good things, of course. But they're hard. You can think of a flexible currency regime as being a way to ease the bumpy process of structural change. Or if you're a country like Greece or Italy you can see it as a convenient if messy way to avoid changing much at all.

At the end of the day, this is why a fixed currency regime is troublesome for a group of diverse democracies. It stops you from running your country in the way that you might want to.

The real surprise from the Italian referendum

However, all of that said, it doesn't seem likely to me that Italy will be ditching the euro any time soon. Italians might reject reform at the referendum it seems likely that they will. They might even then see the Five Star Movement getting into some form of power.

But we all saw what happened when Greece voted a populist party into power. Even then Greece couldn't bring itself to reject the euro. And the reality is that while Italian voters might be irritated and they might not be that keen on the EU, there doesn't seem to be a burning passion to get rid of it.

Even the Five Star Movement isn't an explicitly anti-euro movement it's more anti-establishment. It'll talk about holding a euro referendum one day, but also of staying within the EU.

In short, I think this referendum will generate a lot of noise, but is unlikely to be particularly important. The big event in Europe the one that has genuine potential to cause an upset will be the French election next year.

Indeed, the real contrarian bet to look at ahead of Italy's referendum might be to consider what would happen if Renzi wins the referendum. Italy has been one of the worst performing markets this year so far. A vote of confidence in the current government might just help to turn that around.