Italian politics are messy even at the best of times. The battle over forming a government took a nasty turn. We’ll give a short overview and then make a few observations, in the hopes of eliciting informed reader input.
The right wing Lega Nord, or League party, which won in the wealthy north, was seeking to form a coalition with 5 Star, which led the polls in the South. One of the things they agreed on is opposition to the Eurozone, so that looked likely to feature even more prominently in any joint policies than it had in their respective campaigns.
The coalition had proposed seating Paolo Savona, a very vocal critic of the Eurozone, as finance minister. The president, Sergio Mattarella, nixed the appointment, which he has the power to do. The coalition’s proposed prime minister, Giuseppe Conte, abandoned his efforts to form a government.
Mattarella has proposed that Carlo Cottarelli, a former IMF official, form what amounts to a caretaker government, with his key task to get a budget passed, which would have the convenient effect of calming down Mr. Market for a while. Italian bond spreads are at their highest premium to German bunds in four years.
However, Lega Nord and 5 Star supporters are not surprisingly up in arms, so the current conventional wisdom is that there will be snap elections in the fall instead.
Mattarella was seeking to appease the bond gods. :
Mr Mattarella, who has the power to approve or block cabinet appointments, considered Mr Savona a threat to Italy’s position in the eurozone, at a time when Italian debt was already taking a big hit in the markets.
“The uncertainty over our position in the euro alarmed Italian and foreign investors who invested in shares and companies,” Mr Mattarella said. “The rise in the [bond] spread increases the debt and reduces the opportunity to spend on social measures. It burns companies’ resources and savings and foreshadows risks for families and Italian citizens.”
Unfortunately, that didn’t work as planned. Mr. Market at first liked the idea, with both the Euro and Italian bond prices rising, but then went into full reverse when they saw the severity of the political backlash.
Note that despite Savona, the proposed economics minister, having a fabulously acid tongue, he had said he would uphold Eurozone rules. So was the issue that Savona was seen as such a fierce opponent to the Euro that he’s renege on his promise or that he could be still be plenty disruptive while not crossing any official lines?
The flip side, as Politco snarked in its daily e-mail:
All the fuss, remember, because the president of the Republic rejected one minister (and this is not the first time that has happened) — who seems to have been so crucial to the whole project that without him, it’s better not to govern at all.
Even though the caretaker Cottarelli does not on paper have the votes to secure a majority, it’s premature to rule that out. Remember there are other factors that come into play….like looking responsible, particularly when Italian banks are still mighty wobbly, and not wanting to have to campaign again, particularly for any representatives who won with less than comfortable majorities.
The right is the big winner in this upset.
Poll out tonight in Italy: M5S drops below 30%, Lega flying: 27.5%, Forza Italia continues its fall, everyone else flat
— Alberto Nardelli (@AlbertoNardelli)
This is not a constitutional crisis. This is a very bitter, high stakes political crisis, but there are not yet any constitutional issues in play, despite 5 Star calling for Mattarella to be impeached.
The underlying issue is austerity and budget constraints. Italy’s economic distress comes from having its GDP contract over the last decade. It needs deficit spending. Eurozone budget rules severely constrain running fiscal deficits.
The worst is the Eurocrats should know better by now. Even the chief economist of the IMF, Olivier Blanchard, said his own data showed that for weak economies, fiscal multipliers were greater than one. That is economist-speak for deficit spending results in even greater economic growth, so that the end result is that debt to GDP ratios fall.
Similarly, Yanis Varoufakis proposed a finesse during the 2015 Greek debt negotiations, a European infrastructure bank. The reason for focusing on infrastructure is it provides for even more fiscal bang for the buck, potentially $3 of GDP growth for every dollar spent. However, colleagues who believe that the Eurozone needs to relax its budget rules said the infrastructure bank idea would run afoul of them as currently constituted. Predictably, Germany nixed the idea.
A fall vote as a de facto vote on the Eurozone….or not? The press has been quick to seize on the notion of an election in the autumn as a vote on the Euro. But it isn’t so clear cut, and the two leading parties may not play that up as much as one might anticipate despite that being their biggest area of common ground.
Recall that in Greece, which has suffered far more under austerity that Italy has, in 2015, the Greeks wanted relief but did not want to leave the Eurozone. It was only some time after Syriza knuckled under to the Troika, that Greek votes turned against the Eurozone.
Italian polls show majority support for staying in the Euro. Like Greece, they want to remain but to have more room to spend. So making Eurozone exit, as opposed to Eurozone reform, the campaign pitch might backfire, and Lega Nord and 5 Star pols have to know that. So until we have the government fall and see how Lega Nord and 5 Star position themselves, it’s too early to say how the campaigns will address the Eurozone choke chain.
Financial time moves faster than political time and may affect outcomes. Italy has been in the throes of a slow-motion banking crisis since mid-2016. The fall in Italian bond prices will put weak institutions under even more pressure. From a Don Quijones post yesterday:
A recent study by the Bank for International Settlements shows Italian government debt represents nearly 20% of Italian banks’ assets — one of the highest levels in the world. In total there are ten banks with Italian sovereign-debt holdings that represent over 100% of their tier-1 capital (which is used to measure bank solvency), according to research by Eric Dor, the director of Economic Studies at IESEG School of Management.
The list includes Italy’s two largest lenders, Unicredit and Intesa Sanpaolo, whose exposure to Italian government bonds represent the equivalent of 145% of their tier-1 capital. Also listed are Italy’s third largest bank, Banco BPM (327%), Monte dei Paschi di Siena (206%), BPER Banca (176%) and Banca Carige (151%).
In other words, despite years of the ECB’s multi-trillion euro QE program, which is scheduled to come to an end soon, the so-called “Doom Loop” is still very much alive and kicking in Italy. The doom loop is when weakening government bonds threaten to topple the banks that own the bonds, and in turn, the banks start offloading them, which causes these bonds to fall further, thus pushing the government to the brink.
Quijones pointed out that French and Spanish banks are big holders of Italian debt too. So too much Italian political stress could morph into financial freakout. Contagion, anyone?
I suspect it did not go unnoticed that European officials were just about as unhelpful as they possibly could be when Italy was pressing for a waiver from its budget rules so it could rescue its banks. In other words, we’ll see soon enough how committed the upstart parties are to their principles when following through with them could produce a banking crisis.