Brussels’ biggest headache will be if Italy quits the Euro

Matt Snape argues that rather than Brexit being the greatest threat to the European Union; the real threat to the SuperState will come should Italy have to leave the Euro.

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Matt Snape
On 23 April 2019 19:30

It is easy to forget southern Europe is suffering financial problems when the mainstream media are focusing on Brexit.

That’s not to say it isn’t important to report on Britain’s delayed exit from the European Union. The EU fear a British exit from their bloc because of the wider consequences it could have on the organisation’s survival. For example, which countries will plug the gap in financial contributions? Which countries may leave next? The consequences Brexit could have on Brussels are profound. And with the Government concentrating on nothing else but this issue, it is no wonder Brexit is still the most hotly reported topic in the press right now.

Nonetheless, Brexit could be the least of the EU’s problems soon. Not only are populist parties likely to storm the European Parliament after May, but there is an economic crisis brewing that will make the 2008 Great Recession appear like a picnic. Already, Germany’s economy is faltering, Greece is gradually recovering from the 2012-15 Bailout Crisis, Spain’s and Portugal’s economies are fragile, and Italy is in recession. But Italy is the nation that we should all be concerned about.

Business Insider reported that Italy could trigger a two trillion-euro financial crisis that threatens the eurozone’s existence. For many economists, they fear Italy’s economy cannot be bailed out like Greece’s was due to the former’s size when compared to the latter. As Nickolai Hubble wrote in ‘How The Euro Dies’, the European Central Bank can only buy 33 per cent of a country’s debt. Because Italy’s debt has reached two trillion euros, that means there is only so much of it the ECB can buy before the country defaults on its debts. Debt to GDP has risen to 130 per cent, a level not witnessed since the Second World War. Jack Allen, an analyst at Capital Economics, told Business Insider this is a ‘perma-recession’, and warned it could threaten the eurozone’s survival.

The ECB is guilty of funding a debt crisis that originated in the 2000s. Because the central bank applies a universal interest rate to all eurozone countries, this means it can fuel or hinder borrowing in certain nations. During this time, Italy, Greece, Spain, Portugal and Ireland were guilty of borrowing money at low interest rates, which fuelled property booms in their nations, only to see them bust in 2008. The ECB stripped central banks in these countries of their power to apply an appropriate interest rate to their individual nation. As a result, all the nations listed above suffered due to the borrowing the ECB encouraged. Therefore, Italy is in a mess today. As Business Insider reported, the ECB’s rules make it incredibly difficult for a country to leave the eurozone without defaulting on its debts and devaluing a new currency. This was the same situation Britain faced in 1992 when it left the European Rate Mechanism, the euro’s predecessor. Except this turned out to be the best decision the UK made that year because there was a period of uninterrupted economic growth until 2008.

The ECB also hinders how much a country can spend in a recession. The institution limits spending to 2.04 per cent of GDP. This is the wrong time to prohibit spending as it could act as the short-term stimulus Italy needs to lift itself out of recession. Nicola Nobile, an analyst at Oxford Economics, informed Business Insider Italy will miss its fiscal targets agreed with the European Commission in 2018. Furthermore, investors fear a default or an exit from the euro will become likely if the government cannot sustain its debt.

In the 1980s and 1990s, Italians had more purchasing power than Americans because they could competitively devalue the lira. If Italy crashed out the euro, which is the only way to devalue its currency and return to purchasing levels witnessed at the end of the twentieth century, they would have to repay 500 billion euros in debt. Business Insider claims this is the equivalent of a third of Italian GDP. Analysts predict a breakup of the eurozone is the only solution to this situation.

Nikolai Hubble predicts that, whilst leaving the eurozone will be the best solution for Italy’s economy in the long-term, it will still trigger the worst financial crisis in history. 7 per cent of the UK workforce is employed by the financial system. It pays 11.5 per cent of taxes and it has a £72 billion trade surplus with the EU. UK banks own a certain amount of Italian debt and lend to institutions across the globe to spread risk. This was the same mistake British banks made prior to 2008 when a Lehman Brothers collapse toppled the FTSE100. A eurozone collapse would be even worse.

The ECB encourages capital to flow between different nations through its Target2 system. The purpose of Target2 is to create a trade balance, otherwise Greece would be short of euros and Germany would be overloaded with them. When the Greeks buy German cars, Target2 is the system that sends the money back to Greece in the form of a loan. It is an automated bailout mechanism for southern Europe with no limit or costs and no obligation to pay it back… ever.

Target2 forces countries with surpluses to finance those with deficits. This means Germany pays for Portuguese, Irish, Italian, Greek and Spanish (PIIGS) debts. If they didn’t, the euro would have failed in 2012. Professor Philip Turner said Target2 encourages lending on a significant scale that can go on indefinitely. As Hubble explains in How The Euro Dies, Target2 is a lose/lose situation. It prevents northern European countries from realising an immense part of their wealth and prevents southern European businesses from exporting at competitive prices. Germany cannot use its surplus to accumulate foreign assets, but instead finance Target2 debts. If Germany and the PIIGS remain in the eurozone, importing nations like Greece cannot compete with German goods unless they abandon Target2. If Italy quits the euro, Germany will not see its debts repaid, and they will suffer if Target2 fails. Therefore, no EU country is immune from a default on Italian debts. Germany is always guaranteed its money back under Target2, but as explored earlier, Italy is on the verge of defaulting on its debts, which will trigger a Target2 and eurozone collapse altogether. It is a truly frightening situation.

Brexit is the least of the EU’s problems right now. There is a debt crisis brewing in Europe that will be worse than Black Wednesday in 1992, the collapse of the Soviet Union’s rouble zone in 1993, the 1997 Asian financial crisis, the 2008 Great Recession and the 2012-15 Greek Bailout Crisis. Brussels’ biggest headache will be when, not if, Italy quits the euro.

 

Matt Snape is a freelance journalist whose stories have been featured in numerous national, local and specialist publications

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