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Italy’s debt drama has flared up again in the wake of the European Parliament elections.
As with every other time the Italian debt drama has flared up, it’s mostly a distraction – something to blame market movements on when pundits are bored of talking about trade wars.
But a more significant crunch point could be coming later this year.
Here’s why Italy’s debt drama is in the headlines again
Italy is currently run by a coalition of deputy prime minister Matteo Salvini’s right-wing League and the more politically mixed bag of the Five Star Movement.
It’s a bit (only a bit, mind) like a coalition government of Nigel Farage and Jeremy Corbyn. Not easy bedfellows, you’ll agree, and not necessarily the most stable of alliances.
So the fact that the League was the clear winner in the European elections could persuade Salvini to call a halt to the current coalition and form a new government.
But for now he’s content to pick a fight with Brussels. Salvini wants to cut taxes (which he describes as a “positive fiscal shock”), and spend more money (the word politicians use these days is “invest”, which has the same meaning in their hands as me saying that I plan to “invest” a great deal of money at my local pub tomorrow evening).
Anyway, the European Commission isn’t having any of it. Under a previous prime minister, Italy had told them it was planning to mend its ways.
So on Wednesday coming, the European Commission is set to publish an analysis of Italy’s debt levels “which is likely to show the country is in serious breach of eurozone budget criteria”. And if they don’t do something about it, the commission could issue a chunky fine.
It’s absolutely true that Italy’s balance sheet is a mess. I’m all for cutting taxes, but increased public spending (sorry, “investing”) will not help with Italy’s fundamental problems.
The country is already sitting on national debt worth 132% of GDP (by contrast, Britain’s – which is hardly exemplary – is more like 80%). Spending more will just make that worse.
As we’ve outlined before, by joining the euro, Italy has been locked into a much “harder” currency than it can really cope with. Now, for a country like Italy, joining a hard currency might not be such a bad idea. It should act as an impetus to reform – in theory.
Trouble is, you need your population to buy into the idea. Otherwise, you can forget about reform. And then when hard times hit and you can’t devalue your way out of trouble, the pressure just keeps building up.
And this is the basic problem with the euro. Everyone joined when times were good. Regardless of all the warnings made at the time, people didn’t really appreciate the risks of handing over monetary policy to a committee dominated by the largest countries in the currency zone.
In essence, Italy’s dispute with the EU is about sovereignty. Who gets to make the decisions about how to run the national economy – even if that means running it into the ground? Is it the Italian people or is it a supranational bureaucracy?
It’s the same as the fight over Greece. Except for one thing. Italy is “too big to fail”, whereas Greece was “just about small enough to let go, albeit not without some regret” (I’m sure there’s a good German word for that).
This will all die down again – until the European Central Bank handover
And this is why the European Commission won’t push this. Apart from the pointlessness of issuing a big fine to a country that’s already this deep in debt (not to mention the fact that the French break the rules with impunity), the Commission doesn’t want to start a fight it simply can’t win.
You can’t threaten to bankrupt Italy, because you can’t insulate the European (or global) financial system from an Italian collapse. If global markets spent most of 2011 in paroxysms of panic over little old Greece, just think what the insolvency of the third-biggest borrower in the sovereign bond market would do.
I’ve said several times in the past that the conclusion of Italy’s debt crisis will be for the euro to become more Italian, rather than for Italy to leave.
It’s then up to the Germans as to whether or not they decide to leave the euro and return to the Deutsche Mark. Or maybe they just have an ongoing tug of war, with the euro sometimes being more German than Italian and vice versa, depending on who’s in charge.
I don’t really see any reason to change that view. And I don’t expect this latest flash point to end in anything more dramatic than the rest have.
However, there is a more interesting potential flash point looming on the horizon this year. And that’s when Mario Draghi steps down as the boss of the European Central Bank (ECB).
Draghi saved the euro by figuring out how to get the green light for QE from the Germans, and in the meantime being clever enough with his phrasing to sharply weaken the currency, without actually having to do an awful lot.
If the next ECB boss is less of a diplomat, or less inclined to worry about the “southern Med” contingent – in other words, if we get a German central bank boss, as we might – then all of this might start to matter more.
Let’s catch up closer to the time. Meanwhile, don’t worry too much about any Italian headlines.
By the way, if you haven’t yet signed up to watch our webinar on global trade and currency movements on Tuesday 11 June, please do – you can get all the details here. Dominic and I will be covering a lot of ground and focusing on how British businesses can protect themselves from the turmoil, with currency specialist Alex Edwards of OFX.