Back in May, the reality of Italy’s election struck home in bond markets. The two-year Italian government bond suddenly plunged. And Europe’s banks followed soon after.
Each announcement about who would feature in the Italian cabinet either sent markets reeling, or gave them some temporary encouragement.
At one point, the Italian president even rejected the proposed finance minister. The eurosceptic views of Paola Savona were simply too dangerous for the euro.
So the Italian government cheekily made Savona the minister for European affairs instead… and turned to the moderate economist Giovanni Tria for finance minister. The announcement allowed the market to recover.
But this means both the prime minister and finance minister are now political nobodies with academic backgrounds and weak backing.
The puppet masters remain the deputy prime ministers and leaders of the two governing parties, Lega and Five Star.
The trouble is, this is a rather messy state of affairs. Especially when it comes to the budget, which is due in October.
The prime minister and finance minister must find a compromise between the two governing parties, bond markets, and the EU. But that is simply not possible. There is no such compromise solution.
The governing political parties have promised huge spending, which would collapse bond markets and violate EU rules.
The EU demands more of the austerity that ruined Greece, which would collapse bond markets and violates the electoral promises of the governing parties.
And the bond markets want a credible fiscal plan, which isn’t really possible regardless. Especially with GDP growth waning once more.
Worst of all, the European Central Bank’s rescue mechanisms now require EU approval. Under the rules governing open-market transactions, a country must first submit to bailouts from the two new European bailout institutions. Think of them as a sort of European IMF, the idea being that Europe will deal with the next Greece by itself.
But Italy isn’t Greece. It’s bigger and more belligerent. Anti-EU sentiment will make them resist any bailouts with conditions attached.
In October, all this will come to a head. I’ve been writing about that since April, weeks before the May mini crisis. What’s special about October? Italy must submit its budget for approval at the EU, before the Italian Parliament even gets a say.
But we might not even get that far.
Prime Minister Giuseppe Conte and Finance Minister Tria have been siding with bond markets and the EU. They promised a budget which cuts the deficit, doesn’t involve leaving the euro and only mentioned political promises as an afterthought. The governing parties that the prime minister and finance minister are sort of representing are not happy.
Already, the cracks in the government façade are showing. Italy’s figureheads are wobbling. La Stampa reports that Tria threatened to resign. He is “sick and tired of being the target of outbursts” from the governing parties.
La Repubblica claimed Tria told the prime minister he was “ready to step back immediately”. A senator is already preparing the market for the news by saying Tria’s resignation won’t “cause the government to fall”.
If you think about it, the idea that a left- and right-wing populist party coalition can last in the face of a debt crisis and hostile EU is a bit questionable to begin with. Silvio Berlusconi, cleared by the courts to run for office once more, has been happy to explain this to anyone who’s listening.
What’s really worrying is the change in polls since the March election. Lega has gained enormously. It would be very much in its interest to sabotage the coalition government, as long as it’s done in a way that makes Lega look good. By not giving in to the EU this October, for example…
So far, the government has an impressive level of public support. But all it has managed so far is bluster. In October, the real decisions have to be made.
The trouble is, the stakes are rising so quickly that a political crisis now could quickly become an economic and financial one. GDP growth in Italy is slowing. Since the May mini-crisis, the Italians have delayed issuing bonds. They must now finance a huge deficit in just a few months, just when they also have to negotiate a budget with the EU…
If the coalition government breaks up now because its moderates can’t reconcile the different demands, we’ll be back to the May crisis in days. Only this time, it won’t end.
To find out what will happen instead, click here.
Opportunities in the noise
You’d think war with North Korea has started. The Japanese air force is putting on an air show in my airspace today.
Usually I only have to duck fighter jets on my way to the gym. Which is very demoralising. But today, they’re everywhere.
Operating inside financial markets can feature the same sort of paralysing noise. Traders even call it that – noise. The things you’d best ignore, but can’t help listening to.
The trouble is, each trader has a completely different idea of what sounds you should and shouldn’t listen to.
My friend Eoin Treacy has a promising take on what you should and shouldn’t be listening to. It’s a take that’s caused quite a bit of controversy in recent weeks. And it’s culminated in Eoin writing his resignation letter. Find out more here.
Until next time,
Nick Hubble
Capital & Conflict
Category: The End of Europe