Fra Mauldin Economics:
Italy has a new government, and Matteo Renzi is not in charge of it. The former prime minister kept his word and resigned following his constitutional reform plan’s crushing defeat at the polls. Is all now well in that beautiful land?
Not exactly, though we did see a glimmer of hope this week. Unicredit, Italy’s largest bank, announced job cuts and asset sales that may buy it some time. This does not, however, mean the crisis is over. At best, it means the beginning of the crisis is over. We have a long way to go.
Our first OTB selection today begins, “Chronic inability to separate the probable from the desirable has been the tragedy of 2016.” Those fateful words come from Financial Timescolumnist Wolfgang Münchau, who is normally very calm but now sees wishful thinking about Italy as a major threat. As much as some might wish Italy to remain in the eurozone, Münchau thinks it’s increasingly improbable. Timing is the main question.
A brief sample of his analysis:
One day Italy will be led by a party in favour of withdrawal from the euro. When that happens, euro exit would turn into a self-fulfilling prophecy. There would a run on Italy’s banks and its government’s bonds.
Italy’s fate in the eurozone and the possibility of a President Marine Le Pen of France are two large threats to the eurozone and the EU. If Italy wants to stay in the euro, it needs to send a clear warning to Germany and the other northern European countries that the eurozone is set on a path of self-destruction unless there is a change of parameters.
The next Italian prime minister will need to explain to the next German chancellor, presumably Angela Merkel, that her choice will not be between a political union or no political union, but between a political union or Italy’s withdrawal from the euro.
The latter would imply the biggest default in history.
With those cheery thoughts, we turn next to the Telegraph’s Ambrose Evans-Pritchard. He profiles a Milanese professor named Claudio Borghi, who may well become the finance minister who takes Italy out of the eurozone.
Professor Borghi is doing the ugly but necessary work of defining exactly how Italy can restore its own currency. He would begin by launching a kind of parallel currency alongside the euro.
“The Italian treasury has €90 billion (£76 billion) in arrears on contracts. These could be paid with treasury bonds issued for as little as €50, €20, €10, or even €5, giving us time to create a second currency.
“When the time comes we can then switch to this new currency. It can be done electronically. We don’t even need to print paper,” he said.
Prof Borghi said the cleanest option is for Germany to leave the eurozone. If that is impossible Italy can pass a law to convert its debt obligations into lira overnight – or the ‘florin’ as he prefers to call it, harking back to the days of Florentine ascendancy under the Medici.
“The losses would shift to the national central banks through the Target2 system,” he said. This means the Bank of Italy would repay €355bn on liabilities to eurozone peers (chiefly the Bundesbank) in devalued lira. The Bundesbank would face instant paper losses on its credits – effecting €700bn in the likely event that an Italian exit would lead to a general return to sovereign currencies.
I can only imagine the frowns in Berlin upon seeing the line, “the cleanest option is for Germany to leave the eurozone.” It may well be true, but it’s hard to imagine any German government agreeing to do so.
Münchau and Evans-Pritchard are two of the leading economic commentators in Europe. If they’re this worried about Italy, we should be, too. The first 90 days of the Trump administration will be important to the near-term fate of the US economy, but Italy could be more crucial. Italy is a ticking bomb.
