Could Italy Bring Down the Euro? - Soeren Kern

by Soeren Kern

A move by Italy — the third-largest economy in the eurozone — to abandon the euro could strike a potentially fatal blow to the currency and to the bloc itself.

• Meanwhile, at more than 130% of GDP, Italy has one of the biggest public debt burdens in Europe, second only to Greece.
• "A perfect storm of slow or zero Italian economic growth, low interest rates and politically connected, often corrupt, lending have combined to create a situation where the Italian financial system is in need of a large rescue." — Mihir Kapadia, Sun Global Investments.
• M5S blames the euro for Italy's woes, and many Italians agree.

The eurosceptic Five Star Movement (M5S) has overtaken Prime Minister Matteo Renzi's Democratic Party (PD) in several opinion polls and is now the most popular political party in Italy.

The poll results represent a significant shift in Italy's political landscape and have potentially far-reaching implications for the future of the European Union.

M5S, which would win national elections if they were held today, has called for a referendum on whether Italy, which is facing the collapse of its banking system, should keep the euro, the single currency of the European Union, or bring back the Italian lira.

A move by Italy — the third-largest economy in the eurozone — to abandon the euro could strike a potentially fatal blow to the currency and to the bloc itself.

An Ipsos poll, published by the newspaper Corriere della Sera on July 5, gave M5S 30.6% of the vote, up from 28.9% in April, while Renzi's center-left PD fell to 29.8% from 31.1%.

A Demos poll, published by La Repubblica on July 1, gave M5S 32.3% of the vote, compared to 30.2% for the PD. An EMG Acqua poll for TeleGiornale La7 television on June 28 gave M5S 31.7%, compared to 31.2% for the PD.

According to Ipsos pollster Nando Pagnoncelli, the polls show that M5S "is increasingly viewed as a political force that is capable of governing the country."

The anti-establishment M5S was founded in 2009 by Beppe Grillo, a well-known comedian and blogger who has led a popular fight against rampant corruption in Italy's political system. The party advocates for direct democracy — a system in which political decision making is devolved from the government to citizens — as a way to bypass traditional political parties embroiled in corruption scandals.

M5S, which portrays itself as post-ideological and draws support from both the left and right sides of the political aisle, has leveraged the internet to attract millions of voters, especially among the young.

The 67-year-old Grillo recently handed over the reins of the party to a new "directorate" of five young leaders, of which 30-year-old Luigi Di Maio has become the most prominent. He is widely expected to be the party's candidate for prime minister at the next election.

M5S achieved a major breakthrough in municipal elections on June 20, when it won 19 out of the 20 cities — including Rome and Turin — in which its candidates stood for mayor. The M5S landslide presents a serious challenge to Prime Minister Matteo Renzi.

Renzi has staked his political future on an October referendum in which he wants Italian voters to support wide-ranging reforms to the constitution. The most important reform involves reducing the size and curtailing the power of the Italian Senate in order to ease gridlock in the lawmaking process.

Renzi, who says the reforms are essential to streamlining the government, has promised to resign if he loses the vote. M5S and all other opposition parties are against the reforms, which they say will erode democratic checks and balances.

A Euromedia Research poll conducted on July 1 found that 34% of Italians would vote against Renzi's plan, with 28.9% in favor, 19.4% undecided on which way to vote and 17.7% undecided on whether to vote.

The political uncertainty in Italy is drawing renewed attention to the country's financial woes. Italy's banks are burdened by €360 billion ($400 billion) in bad loans. This figure amounts to more than 20% of Italy's GDP and accounts for one-third of all non-performing loans in the eurozone. Meanwhile, at more than 130% of GDP, Italy has one of the biggest public debt burdens in Europe, second only to Greece. The International Monetary Fund expects the Italian economy to grow just 1% this year.

Mihir Kapadia of Sun Global Investments explains:

"A perfect storm of slow or zero Italian economic growth, low interest rates and politically connected, often corrupt, lending have combined to create a situation where the Italian financial system is in need of a large rescue."

M5S blames the euro for Italy's woes, and many Italians agree. Faced with a financial crisis of potentially epic proportions, the October vote could backfire on Renzi and turn into a referendum on the Italian government itself — and even on the euro.
Writing in the Financial Times, columnist Wolfgang Münchau, cautioned:

"The political dynamic in Italy is not much different from the one in the UK. The electorate is in an insurrectionary mood. The country has had virtually no productivity growth since it joined the euro in 1999. The Italian political establishment has until recently been as dismissive of its chances of losing the referendum as the British establishment was until [Brexit on June 23]. They are still dismissive of the chances of a Five Star victory — and will be until the moment it happens."

M5S's Luigi Di Maio, who, polls show, has a very good chance of succeeding Renzi as prime minister, has reiterated his party's long-standing call for a referendum on the euro:

"We want a consultative referendum on the euro. The euro as it is today does not work. We either have alternative currencies or a 'euro 2.' We entered the European Parliament to change many treaties. The mere fact that a country like Great Britain even held a referendum on whether to leave the EU signals the failure of the European Union."

A referendum on the euro would be "consultative" because Italian law does not allow such plebiscites to change international treaties, including those that involve Italy's relations with the European Union.

Luigi Di Maio, who, polls show, has a very good chance of becoming Italy's prime minister, has reiterated his party's long-standing call for a referendum on the euro, saying "The euro as it is today does not work." (Image source: M5S video screenshot)

But Grillo is seeking a legislative change to allow an "ad hoc" exception, similar to the one in June 1989, when Italy held a consultative referendum on whether to transfer certain powers to the European Parliament. The exception would presumably be approved if M5S wins the prime minister's office.

Meanwhile, analysts are warning that the turmoil in Italy could spread to the rest of the eurozone. The risk of contagion is due to the so-called "doom loop" that exists between European governments and European banks, which have more than doubled the holdings of their own governments' debt from a low of €355 billion in September 2008 to €791 billion today.

International banks have lent Italy more than €500 billion, according to Die Welt, which reports that French banks alone hold €250 billion of Italian debt. German banks hold €84 billion of Italian bonds. The only question, according to analysts, is whether taxpayers or bondholders will be left holding the tab.

Wolfgang Münchau of the Financial Times warned of the consequences of a disorderly Italian exit from the euro:

"An Italian exit from the single currency would trigger the total collapse of the eurozone within a very short period. It would probably lead to the most violent economic shock in history, dwarfing the Lehman Brothers bankruptcy in 2008 and the 1929 Wall Street crash."

As Ambrose Evans-Pritchard of the Telegraph has pointed out, however, Italy must choose between the euro and its own economic survival. Leaving the euro "may be the only way to avert a catastrophic deindustrialization of the country before it is too late."
 

 

Soeren Kern is a Senior Fellow at the New York-based Gatestone Institute. He is also Senior Fellow for European Politics at the Madrid-based Grupo de Estudios Estratégicos / Strategic Studies Group. Follow him on Facebook and on Twitter. His first book, Global Fire, will be out in 2016.

Source: http://www.gatestoneinstitute.org/8468/italy-euro

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