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Debt and catastrophic loops: Italy’s eurozone nightmare | Business | Economic and financial news from a German perspective | DW

ByTina R. Wimmer

Mar 11, 2021

With new UK Prime Minister Boris Johnson apparently slated for a no-deal Brexit for October 31 this year, Halloween is already shaping up to be more gruesome than usual for the EU.

But there’s an even more terrifying story scaring Eurocrats in 2019, and it comes from Italy.

Do you know what a mini-BOT is? It may sound like something out of a robotic, dystopian future, but it’s the informal name given to a potential “parallel currency” that many members of Matteo Salvini’s right-wing League party favor putting into circulation. in Italy.

The idea behind these potential mini-BOTs (literally mini “treasury bills”) is that they could be issued in small denominations and used by the Italian government to pay off part of the mountain of debt it owes to commercial companies. and to suppliers.

It remains to be seen whether mini-BOTs will enter circulation or not. But several Italian economists and analysts have said they could serve as a stepping stone on the road to an alternative currency in Italy if they do.

Matteo Salvini, League leader and future Italian prime minister, once described the euro as “a crime against humanity”

Salvini’s party, which until recently was part of a shaky coalition with the left-leaning 5 Star Movement, is keen to trigger an election year that it believes it can win outright. The latest political developments suggest an election could be avoided, but Salvini is going nowhere and remains a popular figure.

The populist leader has made no secret of his wish that Italy one day leaves the euro zone. So the current political chaos in Italy and the prospect of a majority League government have deep significance for the wider EU – arguably much more than the current paroxysms around Brexit.

Why Italy matters

There’s a famous line in Shakespeare’s Macbeth, when the mad Scottish king says to the rival he’s been most warned about: “Of all other men, I shunned thee”.

That sums up precisely how the eurozone’s financial deans have long felt about Italy, even during the long night that was the Greek debt crisis earlier this decade. As bad as that was, nothing thrills Brussels quite like the thought of an Italian debt crisis.

The reason can be understood quite clearly by looking at the following chart, which shows how exposed European banks beyond Italy’s own shores are to Italian debt, largely government debt.

Credit exposure of European banks to Italian debt FR

Most governments in the world owe a fortune. But Italy’s debt pile would make most others blush. Italy owes $2.3 trillion (2.06 trillion euros) in public debt. This represents around 133% of its GDP, a huge ratio that puts it among the top five in the world.

While the majority of this stock of loans weighs on the banks of Rome and Milan, the European banks are seriously exposed in the event of problem. France is in the hole for a potential of 285 billion euros according to a Bloomberg study, while German, Spanish, British and Belgian banks also have reason to worry.

Although the Italian government’s projections see the percentage of public debt as a percentage of GDP falling to 120% over the next decade, the OECD has recently forecast that it will increase over this period due, among other things, to low growth rates.

Indeed, a looming conflict that adds extra spice to the mix is ​​the prospect of the EU launching disciplinary proceedings against Rome for breaching EU rules on debt and budget deficits.

Doom loop

As the third largest economy in the Eurozone and one of the top 10 in the world, the Italian economy will always have an influence on the wider European economy.

But given the extent to which European banks are linked to Italian debt levels, that link is much stronger than it might otherwise be.

During the years of the global financial crisis of 2007-2008, several banks collapsed. When large banks fail, it has the potential to infect the entire financial system as the contagion effect begins to affect other banks and other balance sheets.

A particularly devastating element of this situation is the so-called “catastrophic loop” of sovereign debt. This is when banks and national governments are so intertwined that a country’s indebtedness can cast doubt on its ability to service its debts, leading to banking chaos.

Considering the numbers at stake in Italy, it’s easy to see why this chills so many people’s blood.

Arrivederci euro, buongiorno mini-BOT?

But if Italian banks haven’t collapsed yet, why should they? After all, the huge public debt in Italy is nothing new.

The simple answer is political. The prospect of Italy being ruled by a party that has actively talked about leaving the eurozone, and even the EU, has only grown since the League and the 5 Star Movement made their initial pact there. a little over a year old.

The debate over mini-BOTs, serious as it is, feeds this perspective. Riccardo Puglisi, an economist at the University of Pavia, told the FinancialTimes earlier this summer that the proposal was “a means of facilitating Italy’s exit from the euro zone”.

If Italy tried to leave the Eurozone in the coming years, there could only be a disorderly departure, if such a departure were even possible. Although still an extreme and hypothetical scenario, a disorderly exit from the euro would increase the possibility of Italy defaulting on billions of euros in debt.

From there arises the specter of what would be the biggest default in economic history.

The implications for Europe in an economic era already shaken by Brexit, the Sino-US trade war and, indeed, the longer-term effects of the Greek debt crisis, are hardly worth considering.

Yet the increasingly uncertain terrain of politics demands that we do so.