Italy's referendum is next test for eurozone stability

Jonathan Boyd
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Italy's referendum is next test for eurozone stability

Italy was one of the six founding members of the European Union (EU) in 1957, along with France, the Netherlands, West Germany, Belgium and Luxembourg. Its referendum next month will therefore be a critical test of whether the eurozone and the EU can survive the pressure from the populists.

If the populists win then the future of the Eurozone and the EU itself will be in doubt.

As is often the case with critical moments, the situation has its roots in a matter of relatively minor importance. Premier Matteo Renzi called the referendum to amend the constitution by approving a reform of Italy’s Parliament.

The problem is that Renzi then made himself the key issue by promising to resign if he lost, as he confirmed to Italian media last week: “ If the citizens vote ‘no’ and want a decrepit system that does not work, I will not be the one to deal with other parties for a caretaker government.”

As a result, the referendum no longer revolves around a comparative triviality. It has become something altogether more significant. Italy is now in a two-week blackout period for polling before the vote on 4 December, but the final polls showed the “no” vote with a comfortable lead. There is therefore a major risk that Renzi will soon follow UK prime minister Cameron out of office. Three quite different scenarios could then develop:

• Another premier takes over. Historically, Italian premiers have not lasted long. Before Renzi took over in 2014 there had been over 50 different premierships since Italy’s first post-War premier, Alcide de Gasperi, resigned in 1954. So the revolving door may revolve again, leading to the President appointing a new premier.

• New elections are held, and another premier takes over. Renzi was the third Italian premier in a row to take office without a personal mandate from an election (following Mario Monti and Enrico Lette). An election may therefore take place, after which the revolving door could revolve again.

• New elections are held, and an anti-euro coalition takes office. This would seem to be the base-case scenario, with a probability of at least 50%. It would likely mean that Beppe Grillo’s anti-euro Five Star Movement would take office with Berlusconi’s Forza Italia and the Lega Nord (Northern League) and would then hold a referendum on leaving the euro – with the aim of capping Italian debts and nationalising its banks, as Grillo has promised.

Given that around €360bn ($400bn) of all Italian loans are classed as “troubled” and amount to around one fifth of total loans, capping the debts would cause major disruption to the Eurozone and global financial systems. It would mean, for
example, that foreign holders of Italian debt would be paid in Italian lira, not euros. And presumably this would be after a devaluation of the lira, which would have a knock-on effect across Europe, forcing many continental banks into bankruptcy.

Global population segments Italy, millions, 1950 – 2030(F)

Population segments in Italy 1950-2030

Demographic reality is now confronting stimulus fantasy

Italy’s real problem is not its Parliament but that its economic policies haven’t adjusted to the New Normal world. Like those in most developed countries, politicians of all parties have failed since the end of the BabyBoomer-led SuperCycle to understand the trade-off that has taken place between increased life expectancy and economic growth. Italy has a median age of 45 years, and as the chart above shows:

• It now has only 24m in the Wealth Creating 25 – 54 cohort, versus 22m New Olders in the 55+ cohort.

• By 2030 it will have just 20m Wealth Creators and 26m New Olders.

• This is completely different from the position in 1950, when there were 18m Wealth Creators and only 8m New Olders.

In addition, of course, Italy has become the main route for migrants and refugees in light of the EU’s deal with Turkey. Some 168k people have already arrived this year, compared to 154k in the whole of 2015 and 170k in 2014. Resources have been further strained by the recent sequence of earthquakes – made yet worse by the lack of anti-seismic regulations for Italy’s buildings.

It is small wonder, then, that the Five Star Movement is amassing support, having won Rome in this year’s elections, whilst the Lega Nord won the Veneto and Lombardy regions.

Nor is it surprising that investors are starting to panic. Italy’s 10-year interest rate has doubled to 2% since the summer – and it could go very much higher if Renzi loses, as the prospect of a vote to leave the Eurozone and cap Italy’s debts comes closer.

This is the Great Reckoning in action, and there is probably little that the European Central Bank (ECB) can do to mitigate the position. In a few weeks’ time investors may well wonder how they allowed Italian interest rates to trade below US rates
for much of the past few years. And in a few months’ time it may well seem equally incredible that anyone ever believed ECB’s President Mario Draghi’s 2012 boast that… “ Within our mandate, the ECB is ready to do whatever it takes to preserve the
euro. And believe me, it will be enough.”

It could be a very difficult H1 in 2017. Next month’s Italian referendum is followed in March by Dutch elections and in May by France’s Presidential election, both of which may well be won by parties committed to leaving the EU itself. It is therefore hard to ignore the possibility that by June the EU could have effectively ceased to exist in its current form. Anyone who hasn’t already started to develop contingency plans for this development may find they have a lot of work ahead of them.

 

Paul Hodges is chairman of International eChem, a consultancy to the investment and global chemicals sectors

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