If there were ever any doubts that the leaders of the Euroskeptic
coalition that now runs Italy has a plan to defy the European Union its
proposed budget should quell them. Both Deputy Prime Ministers, Luigi Di Maio
of Five Star Movement and Matteo Salvini of The League, were adamant about
locking horns with European Union leadership over all issues of sovereignty
between now and May’s European Parliamentary elections.
Their budget
proposal which included both tax cuts and universal income blew past the EU
budget limit of 2.0% of GDP, coming in at 2.4%. It has put their Finance
Minister, Giovanni Tria, in a difficult position because Tria doesn’t want to
negotiate this budget with Brussels, preferring a less confrontational, read
more pro-EU, approach.
Salvini and Di
Maio, however, have other plans. And since I began covering this story last
year on my blog, I’ve said that it was imperative that Salvini force the issue
of the Troika’s demands – the EU, European Central Bank and the International
Monetary Fund – back down their throats on debt restructuring/forgiveness.
What I meant
then, and I was focused on Salvini’s emergence as the leader of this fight, was
that Salvini and Italy, because they are more than technically insolvent, have
all the leverage in the negotiations. The size of their outstanding debt and
the liabilities existent on the balance sheets of banks across Europe, most
notably the nearly $1 trillion in TARGET 2 liabilities, are something Juncker,
Draghi, Merkel and Christine LaGarde at the IMF simply cannot ignore.
But, to do this
Salvini and now Di Maio have to make a good faith effort to negotiate a good
deal for Italy with Brussels, Berlin and the IMF. This is why the budget
squeaked past the 2.0% limit and then they walked it back to 2.0% but with
provisions they knew would anger the EU finance ministers.
The point of
this is to push Brussels and paint them as the bad guys to shift public
sentiment back towards an Italeave position.
Italy’s problems are not solvable with Germany holding the purse strings for
all the EU countries.
So, the first
prong of their assault on the power structure of the EU is this, challenge them
on their budget while making strong statements to the rest of Europe that they
are not looking to exit the euro. If they do, it will be Germany forcing that
situation.
The other prong
of the assault is to remake the EU from within, which Salvini has openly stated
is one of his goals.
It started more
than a month ago when he met with Hungarian President Viktor Orban who agreed
on a strategy of creating a ‘League of Leagues’ to unite the opposition to the
current technocratic rule on the European Commission.
They were clear
then that the goal was to wrest control of the European Commission Presidency
from the coalition backing current President Jean-Claude Juncker.
With the rise
in the polls of Euroskeptic parties across Europe, Salvini and Orban can drive
real change in the structure of the parties within the European Parliament. The
European People’s Party, which Orban’s Fidesz party is a member of, is
vulnerable to losing its senior position in any coalition because of the huge
change in Italy’s electoral make-up along with that in Austria with the less
radical Sebastian Kurz.
But, the big
swing is on the table in Germany. Alternate for Germany (AfD) is now pushing up
towards 20% nationally and the next hurdle for its growth is this weekend’s
Bavarian state elections. If AfD out polls the Greens and denies the CSU a path
to a coalition government without them then that could have spillover effects
for Angela Merkel.
The latest polls have AfD averaging around 11% versus
a strong push up to 18% by the Greens. The CSU has collapsed to just 35%. How
accurate these polls are are anyone’s guess at this point, but given recent
history I would not be surprised to see AfD outperform their polling numbers on
Sunday.
Figure
1: Source Wahlrecht.de
Because if they
do and the CSU/Green total is less than 50%, the CSU may be forced to form a
three-headed coalition to freeze out AfD. And this is assuming that the CSU and
the Greens could form any workable coalition in the first place.
That would
truly upset CSU leaders and the cries to break the Union with Merkel’s CDU
would grow louder.
And with Merkel
dealing with internal CDU disloyalty the possibility rises quickly that her
national coalition could collapse amid external pressure from Salvini and Di
Maio over budget and debt issues.
The markets are
beginning to wake up to the fact that this political battle is not going to go
as smoothly for Germany and the Troika as it did for Greece. Salvini and Di
Maio are not Varoufakis and Tsipras and Italy is simply way more important than
Greece.
The euro is
weakening by the day while Italian bond yields are spiking. Traders do not know
what to do as each statement by an official associated with this fight moves
Italian debt markets by 20 basis points.
And, I
shouldn’t have to say this too many times but 20 basis point moves in sovereign
debt markets is the definition of ‘not normal.’
Populist forces
within the EU are angry and their power is growing. The technocrats in Brussels
still seem to think that the old rules apply but they do not. Scare tactics
will not work on these men because they know that the ultimate move is to
simply make preparations for a new currency, be it the mini-BOT that has been
floated previously by Salvini or a new lira.
My read on the
current state of affairs is as follows. Since the ECB is the only marginal
buyer of Italian debt, which has been the case for more than a year now, any
sharp rise in bond yields is a result of the ECB simply backing off that buying
and market forces taking over.
This is the
ECB’s biggest weapon. It will try to scare everyone by allowing Italy’s fiscal
position to erode quickly making it impossible for them to issue debt at
sustainable yields. But, it does so at the expense of the value of the bonds it
and other European banks already hold. Because they are dropping in value,
undercutting the solvency of those banks.
If the Italian
leadership holds the line and refuse to back down, then they call the ECB’s
bluff on allowing rates to rise. The ECB has to come back in, begin buying to
support the price, and the regroup for the next battle.
That’s what
we’ve been seeing for a few months now in the Italian bond market. That’s where
this war is being waged as well as the headlines. And Salvini and Di Maio
understand it. Because if they didn’t they would have already folded.
Instead they
have doubled down on their opposition to Brussels and Berlin and added new
vectors to their attacks.
This will not
end well.
