ITALIAN SHOWDOWN WITH GERMANY OVER EURO LOOMS CLOSER

Italian showdown with Germany over euro looms closer

Italy’s simmering revolt against Germany, austerity and its own ultra-European elites is coming to a head again, in a reminder that the deep clash of interests between the euro’s north and south remains as bitter as ever.


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Silvio Berlusconi called for a showdown, or 'Braccio di Ferro', with northern powers before Italy loses its chemical, car and steel industries Photo: Getty Images



By Ambrose Evans-Pritchard
4:40PM BST 12 Jun 2013


Something snapped in the Italian psyche last week after the European Central Bank offered nothing to combat the credit crunch asphyxiating small business, and more broadly washed its hands of Euroland’s incipient deflation crisis and catastrophic wastage of its youth.

The next day ex-premier Silvio Berlusconi called for a showdown, or “Braccio di Ferro”, with northern powers before it loses it chemical, car and steel industries altogether.

Mr Berlusconi told Il Foglio that Italy’s government - which his Liberty Party keeps in office - is complicitly serving forces that are destroying Italy. It must instead confront the north, “and particularly Angela Merkel’s Germany”, with a stark choice: either they call a halt to fiscal and monetary contraction, and opt instead for full-blown reflation; or they must expect the victims to snatch back their own destinies.

The battle must be waged quietly, but implacably. Italy cannot let its productive base atrophy further, or allow itself to be sidelined by the “hegemonic methods” of those with the upper hand. “That is what I mean by a showdown. We must find our own national or regional solutions, breaking up euro mechanisms."
The business lobby Confindustria is no longer so far from this belligerent position. “We have shown our willingness to sacrifice, but we must say no to austerity that reduces our companies to their knees and lets others snap up our prize assets at bargain prices,” said Giorgio Squinzi, the group’s president.
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Mr Squinzi said “ill-informed” EU lectures on Italy’s lack of enterprise are a misdiagnosis of what is at root a failing of EU strategy. “We must take Brussels to task and completely change economic policy or we will never get out of this,” he said.

The EU’s prescriptions have been self-defeating even on their own terms, leaving aside the "hysteresis" damage of a youth jobless rate near 41pc. He said fiscal overkill that was intended to bring debt under control has instead caused the debt-to-GDP ratio to soar under Mario Monti from 117pc to 127pc, and 132pc this year.

What complicates Italy’s debate is that its own economists are authors of the shock therapy doctrine. Free marketeers reared at Mr Monti’s Bocconi University in Milan have outdone Brussels in their zeal. They fully back the “internal devaluation” aimed at closing the 30pc labour gap with Germany.

These are the “Bocconi Boys” in Austerity: The History of a Dangerous Idea, Mark Blyth’s narrative of how Europe has come to repeat the errors of the 1930s. Alberto Alesina and Silvia Ardagna were the prophets of “expansionary fiscal contraction”, the idea that output loss from budget cuts can be trumped by greater gains in confidence. Their pep talk to EU finance ministers in April 2010 was seized on as the justification for all that followed.

In fairness to Bocconi, it has economists of all stripes. Professor Alesina has since changed his tune, calling for fiscal stimulus. He no doubt regrets allowing EU enforcers to misuse his work. The austerity doctrine is in any case crumbling worldwide. The IMF’s says the “fiscal multiplier” is much higher than thought in a depression where finance is broken. The Reinhart-Rogoff thesis that public debt turns toxic at 90pc of GDP has fallen apart.

My view is that Europe’s cardinal error has been tight money, the ECB’s failure to offset fiscal cuts with all means at its disposal. But whether you blame fiscal or monetary contraction, the damage is much the same.

For Italy the failure is now plain and the Bocconi Boys are a fading force. It was ideological excess to squeeze the budget by 3pc of GDP last year, in a recession, in one of the few OECD countries near primary balance. Critics warned that this would prove calamitous, and so it did.

Internal demand collapsed 5.3pc in a single year, and is still collapsing. Fixed investment in machinery plunged by 9.9pc. Business loans dropped 6pc and house sales are in freefall. Nominal GDP fell 1.2pc, which means a shrinking base must carry a rising debt load. This is the absurdity of internal devaluation in high debt states: it pushes ratios yet higher as the “denominator effect” kicks in. Like Spain, Italy is damned if it does, and damned it if doesn’t.

Premier Enrico Letta rails against “death by austerity” but has yet to flesh this out, and as a child of the EU Project he is no man for a fight. His policy is to tinker and pray for a global recovery that lifts everybody.

This may happen, but there is a large risk that it won’t. The global credit cycle is turning down. America has yet to absorb the full force of its fiscal squeeze. China has reached credit exhaustion, pumping air into a leaking balloon. The crunch in emerging markets threatens to ricochet back into Europe in the form of a deflation shock.

Italy faces horrible choices. I doubt that a “braccio di ferro” will soften Berlin. “We’d come out with shattered bones,” said Massimo Mucchetti from the Democrats.
It would take a united Latin bloc to force a policy change, and that is precluded as long as French president Francois Hollande cleaves to the Franco-German axis, believing that France can withstand the rigours of a deflation regime. If Italy opts for defiance, it must be prepared to go it alone and have its bluff called. It must really be willing to leave EMU.

A game theory study by Bank of America found that Italy would benefit most among big EMU states from a euro exit. It has a primary surplus, so it would not face an instant funding crisis. It has fat gold reserves, providing bond collateral that could be used to raise €400bn in a crisis. Italian household wealth is €275,200, compared with €195,200 for Germany.

A basket case it is not, and Italy’s industrial barons know it. The country has one great structural problem: it is in the wrong currency with an intra-EMU exchange rate overvalued by 20pc to 25pc.

Whether Italy should call it a day and take back its sovereign policy levers is a deeply complex matter for Italians alone to decide. But the issue is no longer one of sacred destiny. The charisma of the Project is draining away. It is all coming down to brass tacks now.