Just over a week ago I found myself in Milan, explaining to investors the reasons for the Trump phenomenon. Late in the evening, over the usual good food and even better company, I seemingly innocently asked the Italian elite assembled there what was the likely outcome of Prime Minister Matteo Renzi’s coming referendum on constitutional reform. I have never heard a room go so silent, so quickly.
These silences are occurring more and more often for the European elite, as the populist revolutions at their door gather force in the face of their economies’ singular inability over decades to grow at a sufficient pace to retain the superlative quality of life their people have grown accustomed to.
Renzi’s spectacular flame out – polls had him losing by five or six points; in the end he lost by a gargantuan 18 – had little to do with the merits of his proposed constitutional changes regarding political reform. It had everything to do with the fact that Italy’s future is simply not living up to the glories of its past.
The numbers tell the tale. GDP growth in 2015 was an anaemic 0.8 per cent, with the Bank of Italy projecting it will only rise to 1.1 per cent this year. Youth unemployment remains at the Depression-era level of 36 per cent. Overall debt to GDP is an unendurable 132 per cent.
Most tellingly of all, the IMF calculates that the Italian economy will not get back to its pre-Lehman crisis level until 2025, amounting to a lost generation. Coupled with growing anger at a Brussels which has provided scant help during the recent refugee crisis and has been ruinously unsympathetic about the utterly necessary bank bailout to come, Renzi’s catastrophe has many fathers.
Looming dead ahead is the iceberg of bank recapitalisation, which simply cannot be put off for much longer. At present, it is estimated that Italian banks have a miserable €286bn in dud loans on their books. Renzi’s frantic efforts to salvage them have run into the gimlet eyed strictures of the European Commission, inspired by the German Finance Ministry.
The peril for Renzi has been that bank recapitalisation would involve real losses for domestic creditors, who own a large percentage (in European terms) of the domestic bank debt. Hurting them in order to recapitalise the banking sector amounts to domestic political suicide. A new government emerging from the present political chaos will be more than hard pressed to drink of this poisoned chalice. However, a failure to do so merely stores up the mother of all economic time bombs for the future.
A major factor behind the Commission’s intransigence is that these German-inspired rules are themselves new, and were designed in response to the myriad bailouts of the past few years. They were sold to the German public as a tough antidote to writing the southern Europeans a blank check. Giving way on them at the first difficulty – even if it makes sense in policy terms – would itself be politically poisonous for the hard-pressed Merkel regime.
Desperately playing for time in the face of the victorious No forces, led by anti-EU populists in the Five Star Party and the Northern League, it is likely that Italy’s President Mattarella will call for the formation of a technocratic government, so the Italian elite can survive another year, as elections are not scheduled to be held until February 2018. Even if the Five Star Party then wins, managing a constitutional amendment and yet another referendum to leave the euro would be a torturous and uncertain process.
And yet even with all these qualifications, something very very important just happened in Italy. A country too big to fail is now just two moves away from leaving the euro. With little likely to economically change for the better between now and February 2018 (and in fact with the banking crisis likely to worsen), surely Renzi’s catastrophe is the beginning of the end of the Italian elite as we knew it. Surely the demise of the broader European elite itself cannot be far behind.