A fresh global financial crisis unfolding?

Wednesday 30th May 2018

A fresh global financial crisis unfolding?

We all enjoy a little drama….

Some get it via sport. Others turn to the TV soap operas or the celebrity gossip columns in the newspapers….

But here at Money Truths we stick to the financial beat, where we find more than enough catastrophe, crisis, calamity, impending doom, fear, panic, hot air and all-out confusion to keep us entertained in perpetuity….

We don’t know who writes the scripts. But there’s never any shortage of action and we are never too far away from the next cliff hanger….

This week it is the Italians who take center-stage and teeter on the brink – threatening to take the rest of us over the edge with them…

  • Breaking the trust….

Trust, once broken, is something that can be difficult – if not impossible – to repair….

Trust in the Italian system is approaching breaking point this week, thanks to President Materella’s decision to veto the appointment of economist Paolo Savona as finance minister….

His decision effectively thwarted plans for a government coalition between Lega Nord and the more left-leaning Five Star movement – a coalition that had enjoyed widespread public support….

Materella (a dyed-in-the-wool Europhile) justified vetoing Savona’s appointment based on the latter’s long-term opposition to the euro – something, it was claimed, that might provoke an Italian exit from the EU….

Over in Strasbourg yesterday, where the European Parliament was meeting, Materella was praised for doing a great job of ‘defending Italian society, the Italian economy and the future of his country in Europe.’

Outside the Euro-bubble and back in the real world, people and markets were wondering where ‘democracy’ fits into all this….

The will of the Italian people appears to be subordinate to the will of Europhile politicians – Italian and otherwise….

Repeat elections are now scheduled for later in the summer. Given this week’s events, they might now become a de facto referendum on Italy’s European membership – which might, in turn, drive another nail into the coffin of the European project….

  • Markets gets worried – and they react….

If or when you start experimenting with or adopting policies best-suited to a totalitarian dictatorship, investors tend to sit up and take notice….

They begin to worry about what might happen next….

They begin to worry about what other self-serving decisions officials – elected or otherwise – might come up with down the road….

They start to wonder whether an environment where politicians and bureaucrats are free to make arbitrary decisions with impunity is really such a good environment in which to invest their money….

And, if they get worried enough, they react….

This week investors have reacted to what’s happening on the ground in Italy by dumping the euro along with Italian stocks and bonds – a clear signal that trust is diminishing….

The euro hit multi-month lows….  Stocks across the board in Europe lost money in the wake of the uncertainty…. Italian banking stocks suffered their worst day’s trading since August 2016….

But currency and stock markets are just the tip of the iceberg. The real problems lie in the debt markets….

  • Debt just got more expensive….

Italian 2-year bonds are among the most sensitive to any political turmoil – being so short-term in duration….

Yesterday, the yields on those bonds (yields rise as the price of the underlying bonds fall) suffered their biggest one-day increase since 1992….

10-year bond yields jumped 50 basis points to their highest level in over 4 years at 3.38%….

At an auction of 6-month government bonds yesterday, the Italian government had to pay investors the highest yield in 5 years….

As trust diminishes and yields on bonds rise, it becomes more expensive for the government to raise money….

And that’s a real problem for an Italian government that is already up to its neck in debt….

The Italian national debt is currently running at 132% of the country’s entire economic output. That’s compared to 97% in France, 85% here in Britain and just 64% in Germany….

In other words, of the big Euro-zone economies (Italy is the third biggest), Italy is in the worst shape – by far – and things just got worse….

Moody’s, the credit agency, signaled yesterday that the next Italian government would have to do something about the national debt or risk being downgraded….

A downgrade in rating would effectively informs investors that lending money to Italy is becoming riskier….

And that would make future borrowing more expensive still for the Italian government – because investors lending the money (via bond purchases) would expect a risk premium in the form of a higher yield still….

  • Shock tactics and deaf ears….

We are not experts here at Money Truths. We are not trained economists. We have no qualifications or credentials to speak of….

But it does not require an expert or an economist or an MBA diploma to realize that the Italian government needs to restore faith in its political system and its markets – and it needs to do so fast….

We don’t see any immediate way that’s going to happen….

Opposing factions don’t seem able to agree on anything. And the focus appears to be fixed on the survival of the European project rather than the precarious state of Italy’s public finances….

Yesterday, the head of Italy’s central bank turned to shock tactics – telling anti-establishment (for that read anti-European) parties that moves weakening the country’s public finances might undermine confidence and unwind years of economic reform….

We would say that confidence has already been undermined. And that his warnings are likely to fall on deaf ears….

If that’s the case, then one possible future scenario becomes more and more likely….

  • The first domino – but not the last….

We could well be looking at an Italian government unable to raise money in markets no longer willing to take the risk on its paper in sufficient quantities – leaving it unable to make good on its existing obligations and unable to fund its programme….

At that point – flat-broke and tapped-out – the Italian government might have no viable
alternative but to turn to the European Central Bank, the International Monetary Fund or some other willing donor in search of a multi-billion-pound bailout….

In other words, Italy is inching ever closer to the crumbling edge of the cliff. This could be like Greece all over again – but worse and with far greater global impact….

Italy could very well be the next domino to fall. But it wouldn’t be the last in what would surely grow into yet another installment in a global financial crisis that has been off and on for a decade….

Of course, we are speculating. We are trying to divine the future. But we don’t know for sure what’s going to happen. Nobody does.

We just watch the current episode unfold with our mouth agape and bated breath. The consequences will be more far-reaching and more painful, but it sure beats Emmerdale Farm or the latest episode of Meet the Kardashians for raw out-and-out drama….

That’s how it looks from here….

All the best,

Dave Gibson

Money Truths