ANALYTICS

27.05.2018 | World's bankers awaken to full horror of Italy's parallel currency
by Ambrose Evans-Pritchard - The Telegraph

Any move by Italy’s insurgent government to issue parallel liquidity will set off a red alert in financial markets and call into question the survival of Europe’s monetary union, Standard & Poor’s has warned. The rating agency said the ‘minibot’ plan being prepared by anti-euro Lega nationalists and the alt-Left Five Star Movement would create a rival payment structure based on ‘IOU’ notes. This subverts the monetary control of the European Central Bank and risks a disastrous chain-reaction. “People need to be very careful. It is equivalent to introducing a quasi-second currency,” said Jean-Michel Six, S&P’s European strategist. “If we go down that route, it would be a signal to markets that some circles in the coalition were considering exit from the eurozone,” he said, speaking at a forum of the Institute of International Finance. Alexander Privitera, European strategist for Commerzbank, said the currency plan reveals the ‘political culture’ of the leaders now taking charge of a systemic EU state. “It doesn’t take much to understand that this is a direct threat to the eurozone. Certain people in the coalition have this at the back of their minds, and it must be taken seriously,” he said. Investors have been struggling to understand the fast-moving drama in Italy. The risk spreads on Italian 10-year bonds actually fell after the election in March, a sign that markets had ruled out the possibility of an unholy alliance between the two radical parties. It is only in recent days that the spreads have surged. They reached 195 basis points on Wednesday when an unknown lawyer with no political experience and an inflated CV - Giuseppe Conte - was formally appointed prime minister. There is no sign yet of any moderation. “The EU is threatening us with talk of €10bn in budget cuts. I intend to do the opposite,” said Matteo Salvini, the Lega strongman. The alliance has proposed Paulo Savona as finance minister, a man who describes the euro as a “German prison”. Lorenzo Codogno, former director-general of the Italian treasury and now at LC Macro Advisors, said it is a mistake to view minibots as way to finance extra spending. The drafters are hardline eurosceptics who have thought long and hard about how to engineer a stealth exit from EMU. “They are a way to prepare for the introduction of a national currency,” he said. William de Wijlder, chief economist at BNP Paribas, said investors should not assume that the ECB can diffuse any bond crisis in Italy by again conjuring the magical words ‘whatever it takes’. The formula devised by the ECB’s Mario Draghi in July 2012 came with stringent conditions. It was anchored to the Outright Monetary Transactions (OMT) that would - if ever activated - require the backing of the EU bail-out fund and a vote in the German parliament. This was not a problem then because Italy’s leader was the pro-EU Mario Monti. Circumstances have changed entirely. Germany will not underwrite a rescue for a populist government openly defying EU spending rules. “Keep in mind that the OMT had specific rules underpinning it. This is a delicate situation. If there is market stress, we should not think that what happened in July 2012 is going to give us a safety net now,” he told the IIF forum. Peter Praet, the ECB’s chief economist, said the plans of the Lega-Five Star alliance to cut taxes, provide a universal basic income, and lower the pension age, might cost as much as 8pc of GDP. He was coy on whether this would blow up the eurozone’s system of collective discipline, but he issued a veiled warning. “‘Whatever it takes’ must be credible. Central banks must careful to be backed by societies, by governments and their representatives,” he told the IIF forum. Jorg Asmussen, the former German member of the ECB’s executive board and an architect of the Italian rescue in 2012, said the new coalition has been a cold douche for world markets. “It has undermined confidence from Singapore to New York. It puts on the table debt restructuring in the eurozone, which is a no-go zone for very good reasons,” he said. He spoke of shared bitterness in Germany, Holland, Finland, Austria, and Slovakia - among other ‘northern’ euro states - that some debtor countries think they can swat aside agreed rules. This is fatal for eurozone solidarity. Mr Asmussen said it is too early to judge whether the Italian coalition will go ahead with its extreme plans, but if they do it may take months for a fiscal crisis to come to a head. The Italian treasury is 60pc pre-funded for the year. The country has extended its average debt maturity to 6.9 years. “I don’t see difficulties in the short-term’,” he said. The great unknown is how Germany, France, and the EU authorities will respond to defiance from Rome. Rules are controversial. It was Germany and France that first broke the Stability Pact. Germany is in persistent violation of the 6pc of GDP ceiling on current account surpluses. Erik Nielsen from Unicredit said the EU would be well-advised to play softly-softly and avert a showdown. “I don’t think much of what they want to do will be implemented. Reform is very difficult in Italy, whether good or bad. There are buffers. In Portugal there was a lot of anxiety about the new (anti-austerity) government and it turned out to be fine,” he said. “You have to be careful about rules. Every country in the EU has broken rules. If you pre-empt policy options for the future, you are saying in a sense that we don’t have a democracy in Europe,” he said.


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