Too Big to Fail

ROME/BERLIN/BRUSSELS (Own report) - The dispute in the EU over the economic policy of Italy's new right-wing government is becoming more acute in the context of the looming economic upheavals throughout Europe. After Italian bankers warned Rome to continue with the austerity policy applied over the past few years, Italy's new European Affairs Minister, Paolo Savona, called for a €50 billion-investment program. Prior to this demand, he publicly raised the possibility of Italy abandoning the euro. If Italy should exit the common currency, Berlin would have to expect huge losses and presumably write off €120 billion in the Target2 clearing system. In view of this, Germany's Finance Minister, Olaf Scholz, recently called the euro "irreversible." Considerable risks are not only looming because of Italy’s precarious situation, but also because of the escalating trade conflicts endangering exports - the very foundation of the German economic model.

Crisis "Similar to Argentina's"

The dispute in the EU over the Italian new right-wing government’s economic policy is becoming more acute in the context of looming economic upheavals in Italy, as well as in other EU countries. On July 10, the President of the Italian Banking Association (ABI), Antonio Patuelli, emphatically warned the new government coalition - comprised of the populist Five Star Movement and the ultra-right Lega - that Italy must become more active in the EU and regain its confidence, otherwise the country would be threatened with a serious financial crisis "similar to Argentina's."[1] Ignazio Visco, President of the Italian Central Bank, likewise urged the new government to continue to apply the austerity measures - euphemized as "reform policy." In view of Italy's financial sector’s instable situation, he warned, if a new financial crisis should hit, we are now "much more vulnerable than we were 10 years ago." When the new government took office in Mai - coming under strong criticism from Berlin because of its composition - particularly the growing interest burden of Italian state bonds has demonstrated the importance of a prudent and far-sighted policy. Addressing Berlin, the two representatives of Italy's financial sector have demanded in return, that the establishment of a banking union in the euro zone be accelerated with "the same rules regarding banking, tax, bankruptcy, and criminal law for all member countries."

Government Investments Plans

The two Italian bankers publicly disapproved of the additional expenditures planned by Rome's government. In the coalition negotiations, the ultra right Lega imposed a single tax rate, mainly benefiting top earners, whereas the Five Star Movement would like to implement the increase of the "basic income" i.e. unemployment benefits. Rome also seeks to launch a large-scale investment program to revive the sluggish economy. "There is certainly a need for public investments, to be chosen and implemented with maximum efficiency, just as there is a need for a broad and balanced tax reform," the President of the Italian Central Bank, Ignazio Visco, said. It would however "be risky to rely only on them in an effort to get out of the low-growth trap." Since the outbreak of the crisis, Italy, the third largest economy in the euro zone, has experienced the most sluggish economic development in the euro zone, while its public debt has reached around 132 percent of the GDP, the highest throughout Europe - after that of Greece.[2]

"Prepared for Anything"

In the disputes taking place among Italy's elite functionaries over the economic policy, the contrary standpoint is personified by the government's new Minister of European Affairs, whose nomination as finance minister had been thwarted by Berlin as the new Italian government was being formed.[3] About a week after Viscos public criticism of the new right-wing government, Savona called for a comprehensive investment program of around €50 billion for Italy.[4] At the same time, he called on the EU to back the plan instead of insisting on Berlin's favored deficit reduction. Simultaneously, the impeded finance minister - characterized in leading German media as "hostile toward Germany" because of his criticism of Berlin's euro-policy [5] - demanded a massive increase in the powers of the European Central Bank so that it can be "the lender of last resort" for the eurozone. Savona said those who did not agree with this proposal, supported by the entire Italian government, "don’t want a united Europe." Prior to this demand, Italy's Minister for European Affairs had again publicly raised the possibility of Italy leaving the euro zone. Such statements had provoked indignation in Berlin and led to the German campaign opposing his nomination as finance minister.[6] The minister for European affairs warned Italy's senators that Italy could find itself in a situation where "others" will decide Italy's fate. Therefore, one must be "prepared for anything."

967 Billion Euros

The euro zone‘s growing vulnerability to crisis is currently reflected in the ever-increasing imbalances in the European Target2 settlement system, which are already more extreme than they had been at the height of the euro crisis in 2012. Target2 serves as an inner-European clearing system of payments between individual countries within the euro zone. However, in the course of the crisis, gigantic claims of the Bundesbank as well as the deficits of the crisis-stricken countries' central banks have accumulated - a result of the flight of capital from the crisis countries to Germany - considered a "safe haven." The Bundesbank's current claims of around €976 billion stand in comparison to the €465 billion in deficits of Italy's Central Bank. Spain has also accumulated an upper three-digit billion deficit in the Target2 system. Currently, it is primarily the European Central Bank's (ECB) state bonds purchase program - introduced under the Italian Mario Draghi - which had forced the Target2 accounting balance upwards, according to observers.[7] If Italy should withdraw from the euro zone, its high deficits would have to be absorbed by Germany. Providing that all other countries remain in the euro zone, Berlin, in accordance with the capital key, would have to shoulder the weight of around €120 billion. If the euro zone collapses completely, the entire weight would be shouldered by Berlin.

Euro "Irreversible"

With a continued growth in the Target2 system's imbalance - which merely ultimately reflects the trade imbalances in the euro zone - Berlin's allergic reaction to Savona's original nomination as minister of finances is readily understandable. Contrary to Greece in 2015, for Berlin Italy is in fact "too big to fail." In late June, Germany's Finance Minister Olaf Scholz explicitly referred to the euro as "irreversible." This currency "secures our common future in Europe."[8] By contrast, American business media see Germany in a dilemma. Using Target2, Germany has de facto made a huge "bet" of €1 billion on Italy and Spain remaining in the euro zone.[9] Via Target2 financing, the ECB has transferred the value of one third of Germany's GDP to Italy and Spain. Germany will "most probably" get its money back, however, in the meantime, Germany is at high risk. Should the common currency collapse, it would rip a gaping hole in the German balance sheets.

The Risks of Export Obsession

Tensions between Berlin and Rome are likely to be further exacerbated through the economic slump, resulting from the escalation of the trade wars. July 12, the European Commission revised the current year's economic forecast downward, due to the flagging economy.[10] Economic growth in the euro zone will presumably be only 2.1 percent this year, rather than the previously estimated 2.3 percent, declared Pierre Moscovici, EU Economic Affairs Commissioner. There are "many external risks" he warned, making reference to the trade war between the USA and China. "Protectionism is not good for anyone," the economics commissioner declared, "it only produces victims and losses." In fact, the euro zone is particularly vulnerable to a protectionist policy, since Berlin implemented a stringent austerity policy in the common currency zone, during the euro crisis, and - following the German model - oriented the zone toward reaching the highest possible export surpluses.


[1] Thesy Kness-Bastaroli, Andreas Schnauder: Italiens Sprengkraft für den Euro wächst beträchtlich. 11.07.2018.

[2] Giuseppe Fonte, Gavin Jones: Don't take risks with economy, Italy's central bank tells new government. 10.07.2018

.[3] See also Eurokratie.

[4] Italy proposes 50 billion euros of extra spending on investment: Savona. 16.07.2018.

[5] Tobias Piller: Italien will einen Deutschland-Feind in der Regierung. 26.05.2018.

[6] Italiens Europaminister: Euro-Mitgliedschaft hängt nicht nur von Italien ab. 10.07.2018.

[7] Gerald Braunberger: Das Anleihekaufprogramm der EZB treibt den Target-2-Saldo. 03.07.2018.

[8] Hannah Boland: Euro "irreversible" says German finance head Scholz amid fears of Italy exit. 22.06.2018.

[9] Slav Okov: Eastern European Nations Face a Tougher Route to the Euro. 18.07.2018.

[10] Jorge Valero: Trade war starts to dent European growth. 12.07.2018.