March 06, 2018
Will Italy exit the eurozone? Of course not. But it's the wrong question.
We couldn't suppress a smile this morning when we read in La Repubblica that the Italian election result caused serious concern in the European Commission. Europe's establishment would clearly have preferred a victory by the centre-right or centre-left - the devil it knows. The hope is now that Italian radicals will turn out to be like Alexis Tsipras, who also started out wild and has since been potty-trained. We think such comparisons are wrong for a number of reasons. Greece is a small country with zero blackmail potential. And Greece was in a bailout programme, and thus subject to external controls. Italy is none of the above. It is a net contributor to the EU budget. And it is the third largest economy in the eurozone.
The real danger of a populist government in Italy, run by parties that have at one time or another prioritised euro exit, is not that they will actually go through with it. The danger is that their policies would produce such an outcome by stealth.
The issue is what will happen if a crisis hits Will it be their priority to stabilise the banking system? Will they adhere to EU rules on bank resolution? Will they adhere to fiscal targets? Our reading of the economic debate in Italy is that there is growing support among radical economists - those supporting Five Star or the Lega - in favour of parallel currency regimes of the kind Tsipras rejected for Greece. This would take the form of bearer bonds, issued by the government, which people can use to settle taxes. The instruments would thus be immediately accepted in lieu of cash.
Another scenario is a return of the sovereign debt crisis, which would occur if financial markets change their view on the sustainability of Italian debt. It will not be so easy anymore for the forces of the Italian and European establishment to get rid of a recalcitrant government, in the way they got rid of Silvio Berlusconi in 2011. That was only possible because of a largely centrist majority in the Italian parliament that was able to bring in a technical government under Mario Monti. We are in the exact opposite situation now. The radicals are in a majority. Five Star and Lega alone have a large majority between them, and that's even witouth the hard left of Liberi e Uguali and the hard right of the Brothers of Italy, an outgrowth of the former fascist party. The forces of liberal democracy, which ultimately underpins the eurozone's fragile governance institutions, are no longer in a position to call the shots. The next finance minister is very likely to be a member of a party that at one time or another advocated Italy's withdrawal from the eurozone.