Wry & Dry

Italy - when will the balloon go up?

Readers will be familiar with the phrase: "when the balloon goes up."  For those who are not, it derives from the First World War. Whenever enemy activity was expected, observation balloons (this was somewhat before the era of drones) would be released to monitor the enemy troop movements. As a result, the raising of these balloons, which were visible to all, soon became a sign of pending enemy action. 

Image result for cartoon world war one observation balloon going up

And so today W&D is wondering when the balloon will finally go up about Italy.  Don't get W&D wrong.  W&D is a great lover of most things Italian.  Amazing food, wine, vibrancy, history, culture and beauty all packed into a small country.  W&D has wonderful memories of a bottle of Barolo at Villa D'Este, overlooking Lake Como.  'Ardship.

What's not to love about Italy?  Well, aside from Italian drivers, it's about the economia italiana.  By way of reminder:

  • The economy has basically been stagnant for nearly two decades and it's not expected to return to its 2007 level of output until the mid-2020s
  • Its economy is sclerotic, business investment has declined, productivity is stagnant
  • Italy's public debt, at 133% of GDP, is one of the highest in the world
  • The long stagnation has created serious problems in its banking system with high levels of non-performing loans - causing a further drag on economic growth and public finances

Image result for cartoon italian economy

But wait.  There's more!

The good times

The past couple of years have been relatively benign. There has been a modest upswing in the business cycle in the eurozone, a modicum of growth even returned to Italy itself.  But:

  • The upturn has been boosted by temporary factors: the large decline in the euro (boosting competitiveness) and the decline in the price of oil
  • Too little progress has been made during this upturn: the banking crisis got much worse and the public debt/GDP ratio keeps on rising

If relatively good times can't improve these things by much, or not even at all, W&D fears what will happen during bad times.

Problemo numero uno: the euro paradox

The paradox of the euro is that monetary policy is set to the average of conditions across the eurozone, which means that it's too loose for some (Germany) and too tight for others (Italy, Greece, Portugal).   

Within the euro, capital can also move freely to other parts seen as less risky, so capital perversely moves from the parts that need it most (Italy, Portugal, Greece) to those that need it less (the richer North).

If countries still had their own currencies, these moves would have led to a depreciation of the weak currencies and these capital flows would not have affected domestic monetary conditions, but with the euro there is no depreciation and capital is sucked out of the South.  Both depress growth further.

In short, there are quite a few ways in which the euro has been dysfunctional for Italy. The relative calm in the last three to four years have masked these underlying problems, but they haven't gone away.

Problemo numero duo: ECB

The ECB has extended its asset buying program but reduced the amounts of purchases from 80 billion euros to 60 billion euros a month.

But what seems to be happening is that, as soon as the ECB buys Italian bonds, the sellers park their money elsewhere in the eurozone.

Mediobanca estimates that €220 billion has left Italy since the ECB first launched QE. The outflows match the pace of ECB bond purchases almost euro for euro.

No wonder German 2-year bunds went to nearly -1%. 

Problemo numero trio: Italian banks

W&D has spoken ad infinitum ad nauseum about Italian banks: they sit on non-performing loans that comprise 18% of their loan portfolio.  This means poor banking profitability and credit to the business sector that has shrunk 11% in five years. The lack of credit is a further drag on economic growth, now and in the future, making it more difficult for Italy to grow out of its debt burden.

Several Italian banks need an infuse of capital to shore up their books, one of these is Banca Monte Dei Paschi,  the world's oldest bank. But rescue efforts have run into problems with the EU bail-in clauses, putting many small investors at risk.

There is a standoff between the ECB and the EU Commission about these rules. The ECB is more lenient for the use of tax money in bailouts as its overriding aim is the viability of the financial sector. The Commission is attached to the bail-in rules which obliges private investors to cough up first.

The longer it takes to settle these issues, the more problematic they're likely to become unless by some magic, 2%+ economic growth returns to Italy.

Problemo numero quattro: politicians

The Five Star protest movement is leading Italian polls and, together with three other anti-euro parties, they could possibly get a majority in the next Italian elections. These elections are scheduled no later than the end of May 2018.

Readers can join the dots on the disaster that will become Italy: fiasco is, after all, an Italian word [2].

Sommario

Italian public finances are a shambles.  And might get worse:

  • Further economic stagnation
  • The cost of a (mostly) public bailout of Italian banks
  • Rising world interest rates
  • Intra eurozone tensions
  • Political risk

W&D leaves it to readers to ponder the elevation of the balloon.

[1]  The Five Star Movement (Movimento 5 Stelle, M5S) was started by Beppe Grillo, a popular comedian and blogger, and Gianroberto Casaleggio, a web strategist, in 2009. After Casaleggio's death in April 2016, Grillo appointed a Directorate composed of five leading MPs, which was in place until October 2016, when Grillo dissolved the Directorate and proclaimed himself "political head".  Formally speaking, Grillo is also president of the association named "Five Star Movement", with his nephew Enrico Grillo vice president and his accountant Enrico Maria Nadasi secretary. 

The M5S is considered populist, anti-establishment, environmentalist, anti-globalist and Eurosceptic.  The "five stars" are a reference to five key issues for the party: public water, sustainable transport, sustainable development, right to Internet access, and environmentalism. The party also advocates E-democracy, direct democracy, the principle of "zero-cost politics", degrowth, and nonviolence.

Oh dear.

[2] Meaning 'to make a bottle'.  Work that one out.