Against the tide: Italy – another victim of the anger vote
By David Roche
With the sizeable majority voting no to political reform in the Italian referendum, the anger vote has claimed its next victim – Italy. The dominoes of Brexit, Trump and now Italy continue to fall.
For a start, this confirms that the world is on course for irrational economic management.
Much of the benefit of globalization and market liberalization, which have hefted global living standards immensely, will be reversed because the benefits were badly distributed and horribly communicated. That is the fuel that powers populists. It will go on doing so.
For investors, it was the growth in productivity, disinflation and profits that yielded immense wealth gains. Have no doubt. These are not on hold. They are going into reverse.
For Italy and the eurozone, the consequences are more immediate and dire. In Italy, prime minister Matteo Renzi has resigned and been replaced by a caretaker government that will try to bolster Italy's failing banks and find some formula for holding new elections.
But business will not be as usual in Italy, even under a hodge-podge coalition, which will endeavour to keep the opposition Five Star Movement out of power and is quite likely to fail in doing so.
Anyone who wants to invest in an Italian bank in these circumstances needs his head examined. Who will borrow from the banks to undertake productive investment in an Italian economy in an even worse condition than its woeful condition over the last decade? How else are the banks to retrieve their monumental bad debts from corporations or make any money on new loans?
Eventually, the banking recaps will fail. The crisis will run from the banks to the state and from the state to sovereign debt. Italian sovereign yields will move towards 3%, making Italy's sovereign debt burden of 130% of GDP unsustainable. After all, falling yields have contributed a 1.4% of GDP annual boost to Italian public finances. Now the reverse will happen.
The European Central Bank (ECB) will step in to prevent chaos, but that can only be a smoothing operation. The ECB has no licence to lend support to Italy without it being compliant with an EU programme and if its financial market woes are not of its own making – which these most certainly will be.
And there will be no Italian government capable of committing to an EU (or EU + IMF) austerity programme. This vote is a populist uprising against austerity, even when austerity is about sensible reforms.
The Germans can't help because Merkel faces elections next year and bailing out Italy would empower the Eurosceptic AfD party immensely. Worryingly for Germans, all this is happening when liabilities of banks in the periphery of the eurozone are already close to their peak.
Sapping confidence
Italy's vote will empower other populist votes in Europe and elsewhere. It is so powerfully anti-reform that it saps confidence that François Fillon, the centre-right candidate, an advocate of market reform and a downsizing of the French state, will be a walk-over against Marine Le Pen in the French presidential elections next summer. That is now once again a wide-open bet.
The real concern is that gains from an integrated Europe will cease. Populism will make even the incumbent elites grab back more power from the EU to the inefficient nation states. They have been doing so consistently since 2007.
The same will be happening globally. Nation states allocate resources sub-optimally compared to globalization. The result of higher inflation and interest rates plus lower productivity reduces the present value of diminished streams of future profits. Current equity valuations reflect none of this.
Of course, the eurozone is not the only moving part in the global populist jigsaw. If Trump takes extreme actions on trade and immigration or his fiscal plans are watered down into relative insignificance, the US dollar will crest and fall. But that's down the road.
Perversely, I think that the UK will be a short-term beneficiary of this crisis. It will strengthen the support for Brexit, making Theresa May's job easier. The UK's yawning external deficits will be easier to finance for a while until Brexit negotiations start in earnest and rising inflation, due to the pound's devaluation, starts to eat into domestic real income. But that won't happen until around next May.
In the meantime, eurozone shenanigans will mean fewer corporations will abandon the UK ship.
Opinion OpinionAgainst the tideWestern EuropeCapital Markets