The Corner

And now Italy

Europe’s attention may be focused on Brexit, but it’s worth keeping an eye on what may be the next crisis – Italy.

Italy has been in a bad way for a long time now. In an article for the Daily Telegraph written in May, Ambrose Evans-Pritchard sketched out the background:

The story of Italy’s disastrous ordeal with the euro is long and complex. The country had a large trade surplus with Germany in the mid-1990s, before the exchange rates were fixed in perpetuity.  Those were the days when it could still devalue its way back to viability, much to the irritation of the German chambers of commerce.

Suffice to say that Italy lost 30pc in unit labour cost competitiveness against Germany over the next fifteen years, in part because Germany was screwing down wages to steal a march on others, but also because globalization hit the two countries in different ways. Italy tipped into a ‘bad equilibrium’. Its productivity has dropped by 5.9pc since 2000, a breath-taking collapse.

Blame is pointless. The anthropological critique of EMU was always that it would be unworkable to corral Europe’s prickly, heterogeneous nation cultures into a tight monetary union, and so it has proved.

You can fault successive Italian governments, but the relevant issue today is that Italy cannot now break out of the trap. Efforts to claw back competitiveness by means of an internal devaluation merely poison debt dynamics and perpetuate depression. The result before our eyes is industrial implosion…

The official unemployment rate is 11.4pc. That is deceptively low. The European Commission says a further 12pc have dropped out of the data, three times the average EU for discouraged workers. The youth jobless rate is 65pc in Calabria, 56pc in Sicily, and 53pc in Campania, despite an exodus of 100,000 a year from the Mezzogiorno – often in the direction of London.

Evans-Pritchard noted how an Ipsos-Mori poll showed that 48 percent of Italians would vote to quit not only the euro, but the EU itself. And since he wrote his article, the populist Five Star movement has won the mayoralties of Rome and Turin. If that movement is going to fade, it’s taking a long time to do so.

And then there are the banks. Evans-Pritchard describes the growing crisis in the Italian banking sector, “with €360bn of non-performing loans (NPLs) – 19pc of the Italian banking balance sheets.”

This is the highest in the G20,  though some say the real figure in China is close. The banks have yet to write down €83.6bn of the worst debts (sofferenze). They have not done so for a reason. Their capital ratios are too low, hence the gnawing fears of forced recapitalization and a creditor haircut under the EU’s new ‘bail-in” laws.

This is politically explosive. Tens of thousands of Italian depositors at small regional banks have already faced the axe, learning to their horror that they had signed away their savings unknowingly.  The Banca d’Italia said the EU bail-in law has become “a source of serious liquidity risk and financial instability” and should be revised before it sets off a run on the banking system.

The government wanted to follow the Anglo-Saxon model and create a publicly-funded ‘bad bank’ to run off the NPLs but this breached eurozone rules. “They basically tried all possible routes,” said Lorenzo Codogno, former chief economist at the Italian treasury and now at the London School of Economics.

…Italy is now in the worst of all worlds.  It cannot take normal sovereign action to stabilize the banking system because of EU rules and meddling, yet there is no EMU banking union worth the name and no pan-EMU deposit insurance to share the burden. “We’re going to be in big trouble if there is another recession,” said Mr Codogno.

And now, a month later, the EU Observer reports this:

 German chancellor Angela Merkel poured cold water on Italian prime minister Matteo Renzi’s plans to temporarily side-step EU rules on state aid in order to shore up Italy’s struggling banks. Merkel told reporters on Wednesday (29 June) that the bloc’s recent laws offered enough leeway already.

“We cannot renegotiate every two years the rules of the banking sector,” Merkel said.

…Claiming that its banks, in the current situation, pose a systemic risk to the eurozone, Rome sought permission to side step EU state-aid rules for six months. Renzi wanted to inject up to €40 billion without forcing losses on shareholders and creditors.

After that refusal, the American Interest reports what happened next:

Then, on Friday, a privately backed €5 billion bank bailout fund took control of a second Italian lender as nervous markets punished shares of Italian banks it considered undercapitalized. This, in turn, prompted to Italian authorities to consider schemes for propping up the rescue fund. Under consideration: raiding pensions.

As it notes:

Anytime a government starts thinking of pension funds as a piggy bank which can be used for current needs, trouble is near.

Indeed. 

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