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The Italian Crash -- Part 1

No matter where the financial armageddon starts it will impact everything. A generation ago it started in Thailand, which didnít seem to be a globally important economy, but the fallout was not pretty. I suppose collapse in Argentina is normal, and so nobody pays any attention, but supposing the whole mess starts with the collapse of a major economy.

Italy is in the top ten of world economies. It has stagnated ever since joining the euro. Itís banking system is on the rocks, and the budget deficit is not very pretty either. The actual figures donít really mean much these days. There are countries with far worse figures, but Italy has three rather important symptoms that make it special.

First; the economy in world terms is huge and it is going nowhere, except marginally down, and is taking jobs with it. Unemployment in Italy isnít disastrous, but it is not good, and prospects are poor, especially among the young. This means people are not getting more wealthy. They are probably poorer now than when the country joined the single currency twenty years ago. Result: unrest.

Second: The banking system is the most unstable of all the major countries. Several of the main banks are among the closest to collapse in the world. Not content with this, the cross-lending within the banking system is such that a collapse or two will take other non-Italian banks with them.

Personal borrowing is also high. The country is effectively broke with a non-performing economy. What is worse is that there is no sign that things could improve within the perceivable future, and every prospect of them worsening. What is perceived as the cause of this is that Italy has no control over her financial instruments. They are bound to the euro, and the control of the euro is beyond the boundaries of Italy. They are locked into a one size fits all monetary system which is controlled from Germany. Germany needs a tighter financial environment, Italy needs a looser one. The obvious way for Italy to cope is for them to devalue, something which they are prevented from doing, and so the scene is set for a bust-up.

Finally, there is the electorate. On the one hand they rather like the euro. On the other, they are aware that they have no control over their finances and that is making life very difficult. There is one other strand to that, and that is, Italy is the one country in the EU where the North-South divide is perhaps the most obvious, and that is not lost upon the part of the political spectrum which calls itself the Northern League. There were recent ballots which saw the percentage vote for a different relationship with the rest of Italy in the high nineties. The north strongly feels that it is carrying the south, and with economic and industrial hardship across the whole country, that feeling not only hurts, it is beginning to fester. And so you have the environment for some kind of bust-up.

What form does that look like taking?

Difficult to predict the future, as always, but here are a couple of scenarios. The most obvious is a political blackmail to Brussels. Loosen the strains on our economy or weíll leave the euro. If that should happen, the existence of the euro as we now know it will no longer be a reality. Thatís a tough piece of blackmail.

Brussels could counter with making things even tougher for Italy. That seems on the face of it to be a daft move, but it will impact even worse on the population, who, the idea goes, will demand another election, and throw out the parties causing the trouble, and things will go back to the disastrous normal. That, of course, really solves nothing, and leaves everybody waiting for the next threat to undermine the whole house of cards.

Of course, a new election may well produce an even tougher political resolution to face down Brussels.

(Since matters are moving rather faster than I can publish, that scenario has actually played out and failed during the past five or six days.)

The move that is currently in place is a cunning one. It revolves around the state setting up a second, shadow currency, and using that currency to issue bonds. The money gained from selling the new bonds would bail out the government, but not solve the economic problems. But it gains time.

Governments are all for kicking cans down the road. They solve things for themselves, and when the next government comes in, the problem is shifted to them. That is not the real way to solve problems.

The interesting question is: what is likely to happen when the bonds have been sold and the money comes in? I think that is easy to guess. The bonds will have two years to maturity. That gives the current government breathing space, but does nothing to ease the underlying problems. What it does do, is get in some extra cash which at the time of redemption will be repaid in the shadow currency, which will no doubt have been devalued by 60% a couple of months prior to the redemption date.

What happens then? Iím not sure how I see anything beyond that date. I would have thought at that point the game would be up. Crash.

If we get to that position, we have Italy in ruins, and a resurrection of the lira at anything north of a 60% devaluation to the euro value. That will lead to a run on the euro, with that currency tanking quite considerably, and plunging the eurozone into economic chaos. Since the euro is used for everyday living and international trade for nearly a third of the planet that spells complete financial mayhem, with gold at $10,000 an ounce, the introduction of SDRs, and crypto-currencies going to the moon.
If that scenario does not pan out something else will take its place to kick the can further down the road and the final bust-up will be delayed again, but it will have to come sooner or later because there is no nice way out of this.

Here are some basic facts gleaned from a recent mailout:
Italy has over $2 trillion in debt outstanding...
Unemployment has been stuck above 10% since 2012 and youth unemployment is above 30%.
Debt to GDP is now at 132%.
Italy spends 10% of its government income on interest expense and 4% of its entire national GDP. Thatís double the OECD average, and the highest in Europe over the last 6 years.
The banks are dumping Italian government debt - according to one firm, banks ditched 12.6 billion euro in December 2017 alone and 40 billion euro in the last three months of 2017.
The Italian banking system had a 16.4% ratio of non-performing loans in the third quarter of 2016.
Deutsche Bank estimates the non-performing loan problem to be even larger now, at 349 billion euro
The country owes the rest of Europe 25% of its GDP... enough that a default would cripple Europe.
Target 2 Balance System. This reveals where money in the Euro system is moving. It shows when people are abandoning ship in one nation and fleeing to another Ė a key sign a crisis is on the way.
Money on the ground is flooding out of the Southern European nations and into Germany.
Either borrowing costs will spike, making Italy's debts unpayable... or the political situation will implode... or so much money will flood out of the country that the economy will fall into a depression it'll never escape from.
This is a property blog so letís draw a couple of provisional conclusions.

Investing in Italy looks to be pure insanity. Do not under any circumstances buy real estate in that country. You could well be buying right before a crash, and a mother of all crashes if it is allowed to play out. Youíd probably lose 60% of your investment overnight.

I would go even further. Investing anywhere in the euro-zone could well produce a nasty result in a couple of years time. There isnít a realistic way out of this. Money is already flowing from southern Europe to Germany. That is creating a further destabilising effect on its own. However you look at the situation, this is an almighty mess.

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