Italy: That Sinking Feeling

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The founding fathers of modern banking face an uncertain future.

Italian elections in March gave two populist parties a majority, but their plans to form a government were disputed by the President, Sergio Mattarella. He feared that the parties’ policies and extremist picks for government would steer Italy towards an overly aggressive anti-European position which could see them ultimately leave the EU and the Euro.

An uncertain outlook and weak leadership has led to a sell off in Italian assets. Yields have soared and stocks plummeted on fears that ongoing political indecision could lead to more elections and gains for the populist movements taking Italy further from Europe and the centre.

Despite progress this week, Italy still has historic and deeply entrenched political divisions and economic problems. So, how did the world’s ninth largest economy become first in line to be the ‘next Greece’?

From renaissance to diaspora

Italy invented modern banking, with the Lombardy’s opening of the world’s oldest surviving bank in Siena in 1472. Aptly, it was recently bailed out. The country also lays claim to inventing modern debt, with tradable bonds used during the Renaissance by commodities merchants. Florence became the world’s first banking centre and Italy ruled the financial world.

But as the age of reason and Enlightenment dawned, and the beauty of the Renaissance dimmed, so Italian global buying power and influence withered. Dutch, British and north west European influence flourished as Italy turned inward, fighting civil wars that only ended after hundreds of years of stagnant growth and political conflict with unification in 1861.

As the industrial revolution boomed in France, Germany and Britain, a unified but mostly illiterate Italy lagged. Still largely divided between north and south, given a lack of resources such as iron and coal, Italy’s only industry was agriculture. Poor economic conditions led to the Italian diasporain the late 19th century, as 9 million Italians sought opportunity away from home.

The Great War and the Great Depression slowed growth further and allowed a disenfranchised population to be convinced by fascism in the first half of the 20th century. Defeat alongside the Axis in World War Two left the Italian economy all but destroyed, weaker than at any point in its turbulent history, leaving a nation down, and almost out.

Il miracolo economico

Post World War Two, powered by $1.5 billion from the Marshall Plan and fully integrated into European trade for the first time, il miracolo economico began. In two decades, a country was transformed, with the automobile and steel industries booming, especially in the northwestern industrial triangle, and land reform in the south helping people out of poverty.

By the 1990s, the Italian economy was the world’s 4th largest, with year-on-year growth fuelled by local industry and exports, and stable government and currency making la bella vita a reality.

That sinking feeling

Following decades of growth, stable Italy played a central role in the birth of the Euro in 1999. But by the early 2000s, like a sinking Venetian palazzo, cracks were beginning to show.

As the Dot Com bubble burst, Italy’s growth slowed, entering recession in 2001. One cause was the age-old Italian problem of productivity. With the manufacturing of cars and steel heading east, Italian companies – famed for quality and design – were priced out by cheaper competitors.

As globalisation boomed in 2000s, Italy’s manufacturing grew less relevant. Unemployment spiked. Italy has always been a country with strict government red tape and is, even today, rife with corruption. A competitive world, driven by America and China, left it behind.

Corruption kills business, and whilst the country has fought its Mafia-gripped past and dismissed its corrupt, megalomaniacal leaders, like a bad dream, they keep coming back. Like in Greece, the world has outgrown Italy, and it has having to borrow vast amounts to keep above water.

Italians showed their dissatisfaction at the polls. Disillusionment with the EU, and public perceptions of how Italy has dealt with mass immigration, has led to the erosion of faith in authority. Populism and a promise of radical change has filled the created space.

Sunk?

In voting for M5S and La Lega, Italians will get more than change. The inexperienced parties and delegates seem unable to offer trust to domestic and international institutions and markets at a time when the Italian economy needs confidence more than ever.

As investors sell Italian assets, it’s hard to see what will stop Italy sinking deeper into the mire. For too long, it has relied on the ECB to prop up its bond markets and banking sector. As this policy comes to an end, it’s hard to see a secure path out from under its mountain of debt.

Structural reforms are needed and promised by the populist parties. But they will take time and great pain to implement, including an increase in public spending that could amount to 10% of GDP, a large figure by anyone’s standards, but extreme when added to Italy’s deficit. It will only be met by increased borrowing, and that can only be achieved by working with the EU.

So something doesn’t add up, especially in light of the fact that Italy has taken 3 months to form a government. The only certainty is that uncertainty will continue. The region’s borrowers should have contingencies in place, in case the era of easy money comes to a halt.

As with Greece in 2010, change can happen quickly. Italy’s future looks unstable, but it could get worse if the country distances itself further from the EU, or, if the ECB (and Germany) decide to distance from Italy. Contagion to other markets (Portugal, Spain) is a threat, too. Next steps by Italy and the ECB will be crucial and closely observed by everyone. They must tread carefully.

The future is uncertain. But then again, it always has been. This is Italy.

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This article was created in association with Origin Markets, directly connecting dealers and issuers in the primary marketplace for the first time. 

Edward Playfair