On the one hand, initial skirmishes rarely determine the outcome of war. On the other, they often reveal the predilections of the key players. That in turn can provide a base line for evaluating later moves, for instance, whether the parties have learned from past encounters and are upping their game, or simply reverting to past form.1
In the case of Italy, both of the two major power players, 5 Star and Lega, are new to the game of EU level politics and national leadership. That means they have a lot to learn, and how good they are at learning is likely to matter a great deal in terms of achieving their larger goals, the biggest of which seems to be allowing the Italian government to spend more.
Let’s look briefly at this first test of the upstarts versus the establishment. Despite 5 Star and Lega succeeding in installing a government, one can read what went down as the parties being daunted by negative market reactions that were well short of crisis level upset. And the wee problem that opponents of austerity in the Eurozone face is that they are stuck in a roach hotel. As we discussed at considerable length in our coverage of Greece, even with Italy’s much large economy, it can’t leave the Eurozone without getting the cooperation of many parties outside its control. Merely printing and distributing paper currency would take the better part of a year, and that’s comparatively simple. Payment systems are fragmented, and the payment players in Italy are not the most important part of the equation. In a very best case scenario, numerous experts have guesstimates that the bare minimum time for software development and testing is three years, which given the lousy success rate of large IT projects, means five years is on the optimistic end of a realistic spectrum.
Now Italy can admittedly defy the Eurocrats and the bond gods on a narrower basis, say by introducing a parallel currency or creating government IOUs designed to be tradeable to increase domestic spending. Emerging economies undergoing financial crises have gone this route and those experiments weren’t successful. California issued IOUs in 2009 when the state ran out of cash due to a plunge in tax receipts producing a $26 billion deficit, and then a protracted battle over what to do about it. Despite it being clear that this was a short-term crisis and California giving a 3.75% interest rate on its IOUs, they still traded at a 60% to 70% discount to face value. And let us not forget that California has a bigger GDP than Italy.
In other words, even though Italy can do great damage to the Eurozone, it will almost certainly suffer more than, say, Germany and France. And since the 5 Star’s and Lega’s mandates are not mainly about opposing the Eurozone for nebulous goals like taking back control that resonated in the UK but about adopting specific economic policies that run afoul of Eurozone rules, like running deficits larger than the sacrosanct 3%, the new coalition partner probably don’t think many of their voters would be keen about making a bad economic situation even worse, particularly if the long-term payoff was at best uncertain.
So with that long-winded introduction, for better or worse, 5 Star and Lega appear to be more sensitive to the weakness of their positions than the press coverage might lead you to believe.
Let’s recap the events of the last few days:
1. After considerable wrangling, a reflection of the fact that the two “populist” parties differ a great deal on policy, 5 Star and Lega agree on coalition and seek to form a government.
2. They propose Paolo Savona, an outspoken Eurozone critic, as finance minster. President Sergio Mattarella, not wanting to spook the market horses, nixes the appointment. The coalition raise the ante by abandoning their effort to form a government. And the market gets spooked anyhow, with Italian bond yields staging their biggest one-day increase ever (admittedly from a very low base) as the ECB pointedly stands pat.
3. The next step would normally be new elections, which if the bond gods weren’t breathing down everyone’s neck, would normally take place in the autumn, but some media outlets suggest that the officialdom was working to hold them in July.
4. Even though the coalition members were very likely not to do worse in a snap election, and had good reason to think they could win more seats, they went into Emily Litella mode. 5 Star recanted its call for Mattarella to be impeached. The two parties, whose brinksmanship looked designed to thwart the technocrats’ having overplayed their hand and force new elections, suddenly decided that might not be such a hot idea. They retreated to coming up with a slightly less provocative lineup of ministers.
And in case you think we are overstating amount of fancy footwork, from Politico’s daily newsletter: “The League rushed to erase signs (both physical in their headquarters and digital on their website) that it was ever in favor of exiting the eurozone” to the degree that Politico is archiving evidence otherwise.
5. It is far from clear how much the coalition retreated. Savona, the proposed firebrand economy minister, is the Minister for EU affairs, and chose another Eurozone doubter, Giiovanni Tria, as finance minister. Given that it is the Finance minister that is a member of the Eurogroup, and members of the European Parliament that have some sway with the European Commission, this posting in and of itself looks like a way for Savona to poke a stick in the eye of European officials. His bully pulpit may be more important than his formal influence. But he could also influence other Cabinet members.
6. Most but not enough European officials kept their mouths shut. The European Commission, however, kept up its usual practice of managing simultaneously to play the clown and the thug. Recall that during the 2015 Greece bailout negotiations, European Commission president Jean-Claude Juncker tried to have the Commission be a central actor when, not being one of the lenders, it wasn’t in a position to throw its weight around. Juncker regularly made pronouncements that were undercut by the real principals, and even made a peculiar display of self pity. It’s been remarkable, in the Brexit negotiations, to see him come off at a mature adult by virtue of comparison to UK officials.
One of Juncker’s picks at the Commission, Budget and Human Resources Minister, Günther Oettinger, who as Bill Black points out, is an unrepentant bigot, said, Markets will teach Italians how to vote.” He was scolded which led him to issue an apology.
— Donald Tusk (@eucopresident) May 29, 2018
But far more serious were the remarks from the ECB. The central bank made clear that it didn’t see the sharp increase in Italian borrowing cots as reason to intervene. Everything looked fine on the banking front. From Reuters:
But three officials told Reuters the ECB was not considering taking any action because indicators were not yet showing signs of stress among banks and the central bank did not have the tools or mandate to solve what was essentially a political crisis.
Specifically, Italy’s borrowing costs were still less than half those seen during the 2010-12 euro zone debt crisis, bank deposits were stable and there was no sign of stress in the inter-bank lending market.
Wolf Richer highlighted the show of the ECB’s fist. From his post:
This is not to say the ECB would never step in and aid Italy. In an interview with the Spiegel, published on May 29, outgoing ECB Vice President Vítor Constâncio, when asked if the ECB would intervene again as it had done in 2012, replied: yes, but there would be conditions – namely an “adjustment program” or commonly called austerity:
“I would like to stress that every intervention has to contribute to the fulfilment of our mandate and is also subject to conditionality. The Outright Monetary Transactions program for intervening in national sovereign bond markets of vulnerable countries can only be used if the country in question also agrees to an adjustment program. The rules are very clear on this. Everyone should remember that.”
Spiegel: “So if Italy wants to circumvent the EU’s fiscal rules, it can’t necessarily count on the ECB’s help?”
Constâncio: “I will only say that Italy knows the rules. They should perhaps take another close look at them.”
It’s important to remember that the Eurozone does not need to be an austerity zone, but Germany and its economic fellow travelers won’t have it any other way. Yanis Varoufakis proposed a short list of reforms that would have done the trick, but he called for Eurozone-level infrastructure funding, which the Germans took (not incorrectly) as stealth fiscal transfers. But that is what the Eurozone needs to work, both economically and politically. Germany has also blocked something arguable even more basic, which is a EU deposit guarantee.
7. As many have noted, the Italy revolt-in-the-making is going to lead the EU to be less willing to cut the UK any slack in the Brexit negotiations, not that the EU was inclined to be charitable in the first place. But do not forget, as has even become the basis for many jokes, that the UK’s position has been and remains delusional: It has asked for a divorce, yet want to preserve all the privileges of being married. From Bloomberg:
EU officials say the deal needs to send a message to euroskeptics in Italy and elsewhere that the bloc won’t adapt its rules to suit countries that want to leave.
“One of the greatest challenges the European Union faces today is the fact that the advantages resulting from a country’s membership in the Union are simply taken for granted,” Luxembourg Prime Minister Xavier Bettel told the European Parliament on Wednesday.
While Italy’s populists have scored a significant victory in taking the mantle of power, governing will be a vastly bigger challenge. I wish them well, for the odds are stacked against them.
1 When we covered Greece’s 2015 bailout negotiation in depth, it was painful to see readers, particularly European leftists who had never read NC before, take our reading of the leverage of each side as well as their bargaining position to assess what the likely outcomes were. We were just about the first to see that there was no overlap between the position of the two sides, which meant the talks would fail, and that in a confrontation, the Troika, via the fact that the ECB was propping up the Greek banking system in violation of its own rules, had the means readily at hand to force Greece to take terms. These readers took offense at the notion that the plucky Greeks, who clearly had the correct economic analysis, nevertheless were certain to lose in the game of chicken that both sides had adopted.