Italian Debt – A Financial Disaster Waiting To Happen

July 3, 2018

The new Italian government will increase public spending and public debt.

It promised to reduce taxes, introduce basic security and reform pensions. Italy’s Northern League’s leader Mateo Salvini surged in the polls and the party is now the strongest in Italy.

A couple of years ago it was inconceivable that this regional group could become Italy’s leading political party. We should expect more to come. As the saying goes, it just could not happen till it happened.

The financial establishments in North European countries like Germany and the Netherlands assume that the politicians of M5S and Lega Nord will follow the Greek script and will backtrack on their promises.

But Mateo Salvini and Prime Minister Giuseppe Conte know that if they do not live up to the expectation of the voters, they will be voted out of office.

They are also aware of it that the Italian voter has still another alternative called “CasaPound”, a much more radical, if for the time being insignificant, social and anti-migration movement.

The planned reforms could burden the state budget with an additional 125 billion euros per year. Can the Italian government afford such a thing?

The question is rhetorical when you look at Italy’s growing debt mountain.

It amounts to €2300 billion, of which 1900 billion are government bonds.

What should worry investors, however, is the structure of this debt. Ten years ago, when the last financial crisis broke out, 51% of these government bonds were hold by foreign investors. When the climate for investment in a country deteriorates, they sell these bonds immediately. When in 2011 the Berlusconi government threatened to withdraw from the eurozone budget rules because of the huge budget deficit, German and French banks sold Italian government bonds BTP (Buoni del Tesoro Poliennali) worth a total of €150 billion. In the following years, foreigners bought Italian debt instruments again for around €100 billion, but their share is now very low at 36%.

Most of the packages currently are owned by Italian banks and insurance companies, and their financial condition is already weak: last year the Italian government rescued, Banca Monte dei Paschi di Siena at the expense of the Italian tax payer, against the wish of the Frankfurt banking establishment. The Italian financial situation became more sensitive when there was turbulence around the new Italian government in May this year: the Italian BTPs (Buoni del Tesoro Poliennali Italian Government Bonds) lost 8% in value. If prices remain under pressure, Italian banks will have to sell off these bonds at a lower price and with huge losses to ensure that their solvency will not be further endangered. To comply with the European debt-to-capital ratios, they have to raise new capital or increase interest rates and grant fewer loans.

Also the ECB is responsible for the rising yield on Italian government bonds. When in May the Five-Star Movement and the Lega merged to form a government coalition, the ECB suddenly reduced purchases of Italy’s national debt, which exacerbated speculation against the BTPs. In this way Brussels wanted to punish the Eurosceptic “populists”. This was confirmed by Günther Oettinger himself, who always considered Italy ungovernable. In an interview for Deutsche Welle, he called the turmoil on the financial market “a signal to Italian voters not to vote for populists from left and right”. In plain language – if they had elected corrupt democrats who were not breaking ranks with Brussels, the Italian debt could have continued to be financed by the ECB.

The introduction of a parallel (or fiscal as the Italian like to call it) currency is one of the promises that the new Italian government has given to make “Italy Great Again”. The central bankers from Northern Europe we talked to are appalled by the idea and are convinced that Italians will not even consider such a plan. Its author – Paolo Savona – the current Minister for Europe – already claimed in 2015 that the denomination of euro national debt into new fiscal currency “nova-lira” national debt was neutral for domestic investors.

This claim is not true, however, because since January 2013 all government bonds in the euro zone have been issued with a so-called collective action clause. CAC means that the issuing state may not change the bond terms on its own: any change requires the consent of the majority of creditors. The share of BTPs with CAC compared to that without CAC has been rising continuously for years. In 2017 it was 48%, this year it will already reach 60%, so that Savona’s plan is hardly feasible.

Italy’s national bankruptcy is imminent and the next financial crisis can soon be triggered off by problems of the Italian banks, which the ECB and Brussels’ technocrats are unwilling to rescue, all the more so since Lega and Movimiento 5 Stelle are in power.

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Mark O'Byrne is executive and research director of www.GoldCore.com which he founded in 2003. GoldCore have become one of the leading gold brokers in the world and have over 4,000 clients in over 40 countries and with over $200 million in assets under management and storage.We offer mass affluent, HNW, UHNW and institutional investors including family offices, gold, silver, platinum and palladium bullion in London, Zurich, Singapore, Hong Kong, Dubai and Perth. 

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