No one tell Donald Trump about Italy's new populist government: Neil Macdonald
Politicians who promised all sorts of foolish things on debt forgiveness are suddenly running the country
Six years ago, confident and sleek and super-rich and looking out over the team of mathematicians he employed to gain even the smallest advantage in the game of buying and selling money itself, John Taylor spoke in absolutes about the destiny of the Euro.
Europe's common currency, he declared, was already dead; "a chicken with its head cut off."
So, Taylor's FX Concepts — at the time the largest currency hedge fund in the world — was "shorting" the Euro, placing large bets that it would tank, or implode. If it did, Taylor would become a great deal richer (and if it didn't, well, more on that in a moment).
He was unconcerned about being denounced as an evil figure by European leaders struggling to contain the Euro crisis across the Atlantic: "It cannot survive. It is unfortunately the truth."
A week or so later, at her headquarters in Washington, D.C., the impossibly self-possessed International Monetary Fund managing director Christine Lagarde shrugged when I asked her about Taylor's big short.
Unwise, she said, to bet against sovereign nations: "At the end of the day, a sovereign is a sovereign, and can actually decide what rules apply and what the principles will be."
A year later, FX Concepts went out of business.
What had happened was precisely what Lagarde predicted: the sovereign governments of the Eurozone, speaking in the person of European Central Bank (ECB) President Mario Draghi, had made it clear they would not allow the bloated debt of Italy, Greece, Spain, Portugal and Ireland to take down the common currency.
The ECB, Draghi declared in July of 2012, was "ready to do whatever it takes to preserve the Euro. And believe me, it will be enough."
That famous, remarkable statement calmed the credit markets, and allowed Italy and other big debtors to keep right on borrowing. Greece, meanwhile, forced its creditors to accept writedowns, or "haircuts," and the ECB bailed it out.
And the Euro crisis, which had dominated headlines for months, seemed to disappear. Life carried on.
But compound interest is one of nature's most relentless forces. The problem only worsened.
Draghi was forced to make good on his vow. In 2015, the ECB began printing money (about two trillion Euros to date) and lending it to the union's more troubled governments, some of which used the relief to make necessary reforms and got their books in order.
But not Italy. Italy just got scarier.
Appealing to Italian voters
For all its beauty and gourmet wonders, Italy is a country with an unsustainable system of preferences, monopolies and entitlements it borrows heavily to maintain, and which its voters seem unwilling to ever give up.
As a result, the country has had practically no economic growth in 16 years. Unemployment is chronic. Its debt to GDP ratio is now about 130 per cent, second only to Greece, which effectively remains a welfare case.
And Italian politicians who try economic reforms, like former prime ministers Mario Monti and Matteo Renzi, don't last long.
Instead, Italian voters favour leaders who tell them what they want to hear: that illegal immigrants, rather than calcified labour laws or Italians' reluctance to have children, are to blame for an increasingly un-Italian and unemployed Italy. Or that Germany's dominance of Europe, and not Italy's overspending and borrowing, is responsible for the state of Italy's economy, or that big tax cuts and a guaranteed basic income are possible, or that the small pension reforms carried out in previous years can be reversed, or that entitlements can continue ad infinitum.
As a result, politicians who declared and promised all those foolish things are suddenly running the country.
The Five Star Movement and the Northern League coalition are threatening to swing a Trump-like hammer (just without the full weight and credit of the U.S. government to back them up), advising immigrants deportations are about to begin, expanding spending, even demanding that the Euro authorities simply write off 250 billion Euros of Italian debt.
(Umm, no, said German Chancellor Angela Merkel over the weekend. We are a monetary union, not a debt union).
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But, absent the restructuring and reforms Italy so clearly needs, and which its citizens so strongly reject, the status quo must continue without end – the ECB will have to keep printing money and lending billions to Italy every month, forever.
That, presumably, can't happen. And the only other alternative is what's been cutely nicknamed the Quitaly – an Italian exit from the common currency.
Which would of course be beyond catastrophic. Unlike little, trifling Greece, Italy is the equivalent of the Wall Street investment banks that nearly wrecked the world's economy in 2008: too big to fail. It is the third biggest player in the currency union, representing 11.5 per cent of the Eurozone's economy. But, unlike those banks, it is too big to bail.
A 'royal mess'
Last year, Draghi formally warned that any country contemplating an exit from the Euro would have to pay its settlement bills upon leaving: In Italy's case, that would be about 380 billion Euros, an amount it does not have, and which, in the chaos that a Quitaly would provoke, the bond markets would no doubt refuse to lend it.
"It will be a royal mess," says Desmond Lachman, an economist at the American Enterprise Institute who has written extensively and pessimistically about the Euro. "It will be like post World War One, when everybody was trying to collect reparations from Germany."
Lachman points out that of the 2.26 trillion Euros of debt Italy owes, 30 per cent is owned by foreigners. If the world thinks the haircut imposed by Greece was disruptive, think about that.
And Greek-style haircuts are a distinct eventual possibility. Remember Lagarde's warning.
Lachman, the great Cassandra, says there is no obvious solution to Italy, but that in no conceivable scenario does it end well. A European recession, in the short term.
Heaven knows what further down the road.
You'd think it would be a big topic for the G7. But that would mean explaining the subject to U.S. President Donald Trump, the great self-proclaimed lover of debt, who is at the moment vastly expanding American borrowing and spending.
He probably thinks Italy's new leadership is finally on the right track.