A nightmare scenario for the eurozone

Beppe Grillo's Five Star Movement is on course to be the biggest party in an Italian hung parliament.

883-Grillo-634

Five Star's Beppe Grillo: planning a break for freedom from the chains of the euro

"The financial markets never got the eurozone quite right," says Wolfgang Munchau in the Financial Times. They often panicked when there was no need and ignored danger until it was staring them in the face. They may now be too complacent about Italy's general election on 4 March, which will produce the famously chaotic republic's 64th government since World War II.

Polls point to a hung parliament, with the populist and anti-euro Five Star Movement currently the largest single party. A centre-right, three-party alliance led by former prime minister Silvio Berlusconi's party (which also contains the Northern League, another anti-euro group) is around ten points ahead overall. The centre-left incumbents, the Democrats, are trailing in third place. Everyone expects gridlock and the subsequent reappointment of the current prime minister by the president. But "I would not bet the house on it".

No big bang for now

Italy has long been the eurozone's weakest link. Chronic mismanagement and overspending have dented growth for decades, and the single currency precluded the old methods of giving GDP a boost: cutting interest rates and allowing the currency to fall. After two decades of stagnation, debt has reached an unsustainable 130% of GDP.

Faster growth would give investors confidence that the debt can be brought under control, but successive governments have been unable to raise the economy's speed limit through structural reforms such as liberalising overregulated sectors of the economy and reducing red tape. Anti-euro populism is on the rise. If Italy, a founding member of the EU, leaves the euro, European integration would suffer a fatal setback.

The "nightmare scenario", says The Economist, is a hung parliament and then a coalition between the Five Star Movement and the Northern League, which the latter says it won't attempt but is apparently contemplating in private. However, both parties have toned down their euroscepticism of late. Five Star no longer wants to hold a referendum on euro membership, while the Northern League, which has previously said that it wants out, now says that the next government should focus on negotiating changes to the single currency.

just a long, slow decline

"That appears to kick Italy's departure a long way down the road," says The Economist. As Capital Economics notes, the anti-euro parties are on less than 50% of the vote, so any coalition would presumably be diluted by another party's less eurosceptic agenda. The odds are that Italy will remain in the euro but keep drifting slowly but surely towards bankruptcy and perhaps a messy "Italexit" a decade or so from now.

Sagging dollar could leap yet and that would flatten Asia

You'd expect the dollar to be performing much better than it has been given America's "improved growth dynamics, higher market rates, and the prospect of a large repatriation of foreign earnings due to a change in the tax law", says Joseph Carson on Bloomberg View.

Instead, it slumped to a three-year low in January. Tax cuts combined with higher spending are giving foreign investors pause for thought. Hence the impending "borrowing binge" means that rates "will need to go even higher to attract the needed savings to balance the US accounts".

That could have global implications, says Pete Sweeney on Breakingviews. Take Asian markets, for instance. "Low interest rates have encouraged Asian firms to borrow greenbacks instead of their own currencies." Asian dollar bond issuance leapt 46% last year and the total value of dollar-denominated credit in the region stood at $1.3trn in the third quarter of 2017.

A dollar jump would increase the local-currency cost of servicing this debt, which "would complicate monetary policies and encourage evacuation from local currencies such as the Thai baht and the Chinese yuan". Tumbling shares are not too worrying, "but a resurgent dollar could really scramble things".

Recommended

The after effects of the gas-price shock
Economy

The after effects of the gas-price shock

In the wake of the recent spike in the natural gas price, we can expect slower growth, an industrial recession – and a newly assertive Russia, says Ma…
17 Oct 2021
The charts that matter: bond yields slip while bitcoin tops $60,000
Economy

The charts that matter: bond yields slip while bitcoin tops $60,000

Cryptocurrency bitcoin soared to over $60,000 this week, while government bond yields fell back. Here’s how that has affected the charts that matter m…
16 Oct 2021
Whistleblower allegations – where now for Facebook?
Tech stocks

Whistleblower allegations – where now for Facebook?

Facebook has come in for some fierce criticism after revelations from a former employee. Just how much damage has been done?
16 Oct 2021
When will supply chains sort themselves out and what might that mean for inflation?
Inflation

When will supply chains sort themselves out and what might that mean for inflation?

Right now, congestion in global supply chains is driving inflation higher. At some point, that will sort itself out. So will that mean an end to high …
15 Oct 2021

Most Popular

How to invest as we move to a hydrogen economy
Energy

How to invest as we move to a hydrogen economy

The government has started to roll out its plans for switching us over from fossil fuels to hydrogen and renewable energy. Should investors buy in? St…
8 Oct 2021
How to invest in SMRs – the future of green energy
Energy

How to invest in SMRs – the future of green energy

The UK’s electricity supply needs to be more robust for days when the wind doesn’t blow. We need nuclear power, says Dominic Frisby. And the future of…
6 Oct 2021
Why the world’s most important economic data release has unnerved markets
US Economy

Why the world’s most important economic data release has unnerved markets

The US added only 194,000 jobs in September, far shorter than the 500,000 that were expected. John Stepek explains why markets didn't react as they no…
11 Oct 2021