Italy’s coalition could sink the euro

The new populist government is on a collision course with the EU, says Emily Hohler.


The single currency forced Italy into depression
(Image credit: Copyright (c) 2017 Shutterstock. No use without permission.)

The new government finally taking shape in Italy, after elections held on 4 March, is "one of the weirdest" coalitions imaginable, says Clive Crook on Bloomberg. It's also "a pretty effective combination if your aim was to sabotage the European Union". Although it's hard to predict "where this Italian misadventure is heading", it could easily be more damaging for the EU than Brexit.

The coalition partners the left-wing populist Five Star Movement and the far-right populist League are "poles apart" on most issues, but united on "immigration, disdain for politics as usual and dislike of the EU". The programme they announced for their country last week combines big tax cuts and spending increases. They are apparently undaunted by Italy's current debt (130% of GDP) and "laugh" in the face of the EU's rules on budgetary restraint.

Expect a bust-up with Brussels

They may well have good reason to laugh, says William Hague in The Daily Telegraph. Italy is going to be told by everyone else in the EU that it would be breaking the eurozone's "strict rules" on big budget deficits. Disappointment and anger could therefore be directed not at the new government, but at Brussels and Berlin.

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The EU can be blamed for denying Italians all the benefits they voted for, the "very same EU" that failed to follow through on its promises to help with the huge flow of immigrants (the coalition is proposing to deport roughly 500,000 illegal immigrants). If the coalition partners wanted to "trigger the bust-up" that could see Italy leaving the euro, then the "stage will be perfectly set".

The populists "don't so much want to leave the euro as blow it up from within", says Jeremy Warner in the same paper. Italy unlike Greece, which tried similar threats is big enough to hold the eurozone to ransom. "If Italy blows, the whole thing blows." To push Italy out of the euro would be very risky for Germany. As the saying goes, when you owe the bank a little, you've got a problem; when you owe it a lot, the bank has the problem.

How the rot set in

You can hardly blame the Italians for this mess, says The Sunday Times. The coalition's programme is a "cry for help". Italy is failing, and the root of its problems is its "fateful decision" in 1999 to join the euro at the currency's inception. Although Italy's debt was at the time roughly double the so-called "Maastricht ceiling" of 60% of GDP, it was "unthinkable" to exclude a founder member. So Italy got the "short-term benefit of funding its debt cheaply but at a cost".

Today the country's per capita GDP is lower than in 1999. While Germany prospered, Italy has become poorer. Youth unemployment is nearly 32%. While countries such as Iceland were able to regain competitiveness by devaluing their currencies, says Paul Krugman in The New York Times, eurozone nations such as Spain and Greece were "forced into a protracted depression" as they struggled to get their costs down.

So what now? Many people think the new government will ultimately accept that the costs and risks of leaving the euro are "simply too high" and be reluctantly forced to explain "the facts of life in a single currency to its despondent supporters", says William Hague. "I am not so sure". Anger in Italy is running high. It is unlikely that Europe will take the "tough line" it took with Greece given that there are "66 years of integration" at stake, says Matt O'Brien in The Washington Post. What's happening is the "circle of life (or rather death) of a poorly thought-out currency". Once the next recession hits, it's going to get worse.

Emily Hohler

Emily has extensive experience in the world of journalism. She has worked on MoneyWeek for more than 20 years as a former assistant editor and writer. Emily has previously worked on titles including The Times as a Deputy Features Editor, Commissioning Editor at The Independent Sunday Review, The Daily Telegraph, and she spent three years at women's lifestyle magazine Marie Claire as a features writer for three years, early on in her career. 

On MoneyWeek, Emily’s coverage includes Brexit and global markets such as Russia and China. Aside from her writing, Emily is a Nutritional Therapist and she runs her own business called Root Branch Nutrition in Oxfordshire, where she offers consultations and workshops on nutrition and health.