What’s Going On In Italy, And Why Are Markets Freaking Out About It?

Will Racke | Immigration and Foreign Policy Reporter

Italy is embroiled in what some are calling its worst political crisis in decades — one that threatens to upend not just the domestic political order but Europe’s entire common currency project.

To American observers accustomed to a two-party system and winner-take-all elections, Italy’s fractious parliamentary politics can seem extraordinarily confusing — if not completely inscrutable.

But the current crisis essentially breaks down into a fight between two opposing camps — the pro-European Union establishment and a coalition of populists deeply skeptical of Italy’s continued membership in the bloc.

How did it come to this?

The seeds of political turmoil were planted in March, when two anti-establishment parties — the right-wing nationalist League and the upstart populist Five Star movement — emerged as the biggest winners in Italy’s national election. Though the two parties have different stances on several issues, they formed a governing coalition over their shared disgust of Brussels’ control of Italian fiscal and economic policy. (RELATED: EU Establishment Reels As Populist Parties Dominate Italian Elections)

Earlier this month, the coalition followed up its jab at the pro-EU establishment by naming Paolo Savona, an 81-year-old academic economist, as its finance minister. Savona has been deeply critical of the common currency in the past, calling it a “German cage” and saying Italy should have an alternative plan to membership in the Eurozone.

Assessing that Savona would be an intolerable threat to Italy’s place in the EU, Italian President Sergio Mattarella used his authority under the Italian constitution to block Savona’s appointment. The move effectively derailed the populist coalition — fresh elections will have to be held as early as July in order to seat a permanent government.

In the meantime, Matarella has asked Carlo Cottarelli, a former International Monetary Fund economist, to form a technocratic administration to oversee the government. The choice of Cottarelli, a solidly pro-euro technocrat known in Italy as “Mr. Spending Review” and “Mr. Scissors,” enraged the populist coalition. Five Star leader Luigi Di Maio called for Mattarella’s impeachment, while the League’s Matteo Salvini questioned whether Italy was nothing but an EU-controlled colony.

What do the populists want?

Although neither Five Star nor the League has explicitly called for abandoning the euro, both parties are seeking to redefine Italy’s relationship to the EU government. They have promised to renegotiate Eurozone agreements that mandate budget discipline and strict spending limits, blaming Italy’s anemic economy in part on Brussels-imposed austerity measures.

Like populist and nationalist movements in other corners of Europe, the Five Star-League coalition resents Germany’s domination of EU fiscal policy. Its economic plan rejects the EU’s budget deficit limit of three percent of GDP and instead seeks to grow Italy’s economy through the “the revival of internal demand,” or increased deficit spending.

The anti-euro populists are buoyed by the fact Italy has become objectively poorer in the common currency era. When adjusted for purchasing power, Italy’s GDP per capita is lower today than it was in 1999, when the country joined the euro. Its overall unemployment rate has hovered above 10 percent since 2012, and its youth jobless rate has stayed well above 30 percent over the same time.

The coalition has also harnessed popular anger at EU immigration policies, which have forced Italy to bear the brunt of continued mass migration from North Africa to Europe. It has demanded the EU provide more funding to house illegal immigrants and, eventually, deport most back to their home countries. (RELATED: Poll: Immigration Is The Top Concern For People In Nine European Countries)

What does Italy’s political crisis mean for the euro?

Political upheaval in Italy is nothing new — the country has had more than 60 governments since World War II. But financial markets in Europe and around the world have been watching the crisis with apprehension over fears that new elections could further strengthen the populists and make a euro exit more likely.

Italy’s 10-year bond yield — a measure of the country’s sovereign borrowing costs — shot past three percent on Tuesday (the highest in four years). Meanwhile, the euro fell to its lowest level against the dollar since July 2017, the Wall Street Journal reported on Tuesday.

Looming in the background is Italy’s enormous sovereign debt burden of 2.3 trillion euros — the largest in the Eurozone. The situation has evoked painful memories of the European debt crisis of 2010-2011, when four highly indebted countries — Greece, Portugal, Ireland and Spain — had to be bailed out by the European Central Bank to prevent catastrophic defaults.

The difference now is Italy, with the third largest economy in the EU, is a much more important to the integrity of the euro than the countries involved in the debt crisis at the turn of the decade. If Italy were to exit the euro, the single currency would not likely survive, many analysts say.

“There’s an existential threat hanging over the single currency if we head into more elections this summer,” Kit Juckes, chief foreign exchange strategist at Société Générale, told TheWSJ. “I don’t know how we get away from that now, given the scale of the financial implications.”

It remains unclear whether new elections will be held this summer or be pushed into 2019. In either case, they are expected to be seen as a referendum on Italy’s membership in the Eurozone.

If current polls are any indication, fresh elections would actually strengthen the populist coalition: the League has gained three percentage points over the last week, while the centrist Forza fell off by almost two points.

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