Italy's fight with EU bullies is part of Euro disaster story

The logic of EU federalist insanity continues to play its part in the downfall of European democracy. Italy's ugly fight with Brussels bullies over the budget is just the latest chapter. Thank goodness for Brexit!

Juncker in anther shouting match
Tim Hedges
On 31 October 2018 11:30

When considering the Italian economy it is important to remember that the Italians gave us the words ‘imbroglio’ and ‘fiasco’. It seems there is nothing that cannot be turned into a controversy.

Take the unseemly row over the budget deficit. Italy declared a deficit of 2.4% for the year to come. It is fairly low by Italian standards and not high by French standards; indeed it is lower than France’s proposed deficit for 2019. And yet an almighty row is brewing in Brussels.

Brussels says that Italy had promised to reduce its deficit for next year to 0.8% and to permit such a change of direction would be unfair to those countries which have suffered. Italy says that it is a sovereign nation and can make its own budget law.

In this Italy is technically wrong: you can either belong to the euro or be an independent nation, not both.

The Italians, however, also point out that this deficit number is not the whole story. Italy has a mountain of legacy debt, accrued in the 1980s and 1990s: not caused by any government in the last quarter of a century. And that debt has to be serviced. Without the debt payments, Italy runs a surplus (known as a primary surplus) even bigger than Germany’s.

But Brussels and Berlin say rules are rules, and there is a marked feeling among Europe watchers that Brussels is deliberately raising the tension. This brings back memories of the Greek crisis of 2009. Then the EU talked up the problem until it was certain that Greece would have to enter into a wholehearted rescue plan, and Germany and France used everyone’s money to bail out their own banks’ exposure.

That was something which the EU could (just about) afford. There is the danger that, as with the proposed absorption of the Ukraine, the political hearties would run at it with enthusiasm until it was discovered that the bill was too big. But Ukraine or part of it could be left to Russia and the rest left to beg. No one can afford to bail out Italy or to let it go under.

Here is how the disaster could take place. Italy’s GDP is a bit short of €2 trillion. So the extra 1.6% that the government is proposing amounts to around €32 billion. Italy’s debt however is 130% of GDP at €2.6 trillion. If the EU’s mischief making causes market tension so Italy’s debt service costs rise. In the medium term, over which the debt has to be refinanced, each extra one percent in interest rates costs €26 billion.

If, as seems likely, the Italian government finds itself paying 2% more than it otherwise would have, the negative effect on the economy is going to be €52 billion against the government’s proposed €32 billion expansion. So this expansionary budget could turn into a recessionary one. Disaster.

Some €370 billion of Italy’s debt is held by Italian banks. If the value of their holdings goes down (the price of a bond falls when interest rates rise) they will need to seek more capital. Many are already stretched. Where will that capital come from if the markets are edgy? You, Mrs Merkel?

These numbers are approximate, and it doesn’t all happen at once. But it is clear that critical talk in Brussels could flip Italy into recession. Italy has an average bond maturity of ten years, so €260 billion has to be rolled over every year. If Italy doesn’t have access to the bond markets who is going to take that on? You Mrs Merkel, if you are still there?

Now, with this intransigence we see a crisis ahead in which there will be no winners.

The talk in politics is that the popular Mr Salvini will try to call a general election in Italy to enforce his sole mandate without Mr Di Maio. If that is the case he may try to introduce Berlusconi’s plan of a parallel currency as a prelude to leaving the euro.

If that happens, the whole game is up. Brussels should stop antagonising Salvini and the Italian people and accept the legacy debt argument. It should do what it does best: shut up and kick the can down the road.

Tim Hedges, The Commentator's Italy Correspondent, had a career in corporate finance before moving to Rome where he works as a freelancewriter, novelist, and farmer. You can read more of his articles about Italy here     

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