Italy – epicentre of the next financial earthquake….

Monday 25th July 2016

Good morning, friends,

In this issue of Money Truths….

  • No financial Armageddon – at least not yet….
  • The rebalancing act….
  • The dangerously sick man of Europe….
  • The bail-out is coming….
  • The natives are restless….

No financial Armageddon – at least not yet….

Prior to the Referendum on EU membership, we were subjected to ‘Project Fear’.

The incumbent Prime Minister, his Chancellor, senior politicians, business leaders and other ‘Influencers’ all promised the British people misery, mayhem and catastrophe if we were foolish enough to vote Leave….

‘Britain would be poorer by £4,300 per household….’ (George Osborne, 27th February 2016)

‘The value of people’s homes will be affected and people trying to get on the housing market will be hit….’ (George Osborne, 8th May 2016)

‘Across Britain as many as 820,000 jobs could be lost….’ (George Osborne, 23rd May 2016)

Health Secretary, Jeremy Hunt, said the NHS would be ‘starved’ of cash. Energy Secretary, Amber Rudd, said energy bills would ‘soar’. Education Secretary, Nicky Morgan, said a Brexit vote would ‘devastate’ the life chances of children and young adults….

We were told businesses would vacate the country overnight. President Obama told us we’d be at the back of any trade-deal queue….

We were told living standards would fall immediately and forever. There wasn’t a single facet of everyday life that wouldn’t be negatively affected if we turned our backs on Europe.

Markets would collapse. Irreversible economic meltdown would ensue. Taxes would be raised – immediately. Our very lives would be threatened. We were told terrorists, rogue nations & Putin all supported Leave.

But a month on the picture looks a little different than the one promised. Mr. Cameron has departed. Mr. Osborne too – jettisoned along with his fiscal policies. Other key players have moved on.

And whilst Brexit did succeed in producing ultra-short term uncertainty and a definite market wobble, and whilst the long-game is still to be played-out, there aren’t many people expecting Project Fear’s dystopian vision to materialize imminently.

It won’t be straightforward or plain sailing. Britain has challenges to overcome. But it won’t be some economic version of Armageddon either.

At least not yet….

The rebalancing act….

On Friday the FTSE 100 (an Index of the largest companies listed on the UK stock exchange) was close to its 12-month high.

The FTSE 350 (an index of medium-sized companies with a domestic focus) had recovered most of the ground lost immediately after the Brexit vote.

But it wasn’t just Britain affected by the Brexit vote. When one of the World’s biggest economies is wobbled, the ripples spread far and wide.

Global markets were unprepared for and shaken by the news of Britain’s impending exit from Europe. Markets lost US$ 3 trillion of value in 48-hours….

For a moment the global economy was like a boxer caught flush on the temple. The legs had gone. One additional blow might have put it on the canvas

But just as boxers find a way through adversity, so too do markets. Three weeks on and global markets have bounced back too. Last week In America the S&P 500 and the Dow Jones Industrial Average traded at all-time highs….

So the turmoil is over? The markets have regained composure? The ship has steadied?
The road to continued prosperity lies directly ahead – flat and straight as far as the eye can see. Right?

Errr…. Maybe not….

I’m not George Osborne. I have no reason to terrify you on a Monday morning. But….

Whilst Brexit didn’t bring down Britain, Europe or the global economy, it might just have been the first blow in a combination of punches that eventually does….

The dangerously sick man of Europe….

Italy has some big problems….

Big deal, you might say. What’s Italy got to do with us? Isn’t this one of the reasons we voted to leave the EU in the first place – so we don’t have to deal with problems created by dysfunctional European nations that don’t speak our language?

Let the Italians go the way of the Greeks, you might say. Let Rome learn from Athens. Let the Italians muck out their own stables.

I see your point. Trouble is, Italy is a different animal to Greece. Italy is the 4th biggest economy in Europe. It’s a big player.

Greece’s financial ills can be absorbed and contained to a large extent. But it won’t be the same story with Italy. If some kind of financial earthquake hits the land of the boot, the tremors will be felt all the way across Europe.

Cracks will appear everywhere. Things will come crashing down all across the European continent and beyond. We certainly wouldn’t be immune to the fallout in the UK.

If it goes bad in Italy, it could even signal the end of Europe – or at least the end of the economic experiment that is the European Union and the euro currency.

The earthquake is brewing in the banking sector. Italian banks are carrying a lot of ‘non-performing’ loans – loans worth 360 billion euros….

We’re talking about 18% of all Italy’s loans. To put that figure into perspective, consider this:when things went bad in the US back in 08/09, non-performing loans represented just 5% of total loans….

Italian banks are in a mess – make no mistake. They’ve hung on to the bad debt for years, refusing to write it down because they didn’t want the ordinary householders who invest in bank shares and bonds to take a hit.

Instead they waited in vain for an economic upturn that never materialized – and now the problems are compounded.

More and more borrowers with outstanding loans can’t afford to repay them….

And banks are struggling to find the credit to issue new loans to fresh borrowers….

In other words the banks are running short on funds….

And what reserve funds they do have are eroded by the negative interest rates introduced by the European Central Bank (ECB) two years ago.

The rate stands at -0.4% and means Italian banks pay the European Central Bank 4 euros for every 1000 euros on deposit. It adds up. The banks are effectively leaking money.

And all-time low interest rates mean banks must accept smaller margins on loans they do make than was the case previously.

The bail-out is coming….

Take all these things together and you’re looking at a perfect storm. Not on the horizon but gathering overhead….

Shares in Italian banks are plummeting faster than a man whose parachute has failed. Individual bank stocks are down up to 80%.

That’s a big number and tells us that confidence in the banks – institutions which underpin the Italian financial system – has completely fallen away.

Sooner or later these banks will be bailed out. Like so many banks before them they will be considered too big to fail.

The Italian government has already talked about re-capitalizing banks using taxpayer money to buy bad loans at knock-down prices.

Last week Mario Draghi, head of the ECB, said he’d support a bailout ‘in exceptional circumstances’ – which would see the ECB giving banks money that Italian taxpayers would have to repay.

Meanwhile the European Union wants investors and bondholders to take the first hit – before taxpayers are squeezed. They want to set a precedent.

The European Union doesn’t want banks and shareholders across Europe (Portuguese banks are in trouble too) looking at taxpayers as an automatic go-to source of bail-out cash when things turn sour. It wants shareholders to accept that capital invested in banks is at risk and not an insurance policy that guarantees a no-lose positon.

Whatever happens in Italy will represent a short-term solution only. Current problems will eventually re-occur because the Italian economy is stagnant and set to remain so.

The economy hasn’t experienced any meaningful growth since the country joined the euro in 1999. Only last week the International Monetary Fund said the economy won’t return to pre-2008 levels until the mid- 2020s. Unemployment is at 11%. Government debt is second only to Greece’s….

The natives are restless….

In short, Italy is the new sick man of Europe. And the prognosis is gloomy. The natives are unhappy and restless.

Many want change and the Five Star Movement – a protest party launched in 2009 by comedian Beppo Grillo – rides high in the polls.

This populist party want a European referendum. They blame the euro for Italy’s malaise and want the lira back.

They also want a minimum income for all citizens – whether or not they work.

And they campaign relentlessly on the theme of honesty – they stand opposed, like many ordinary Italian voters, to the corrupt political culture in Italy….

In the current climate such ideas are seductive to voters. If the Five Star Movement were to force a referendum or to gain power and implement its policies, the shockwaves would be felt far and wide….

Britain’s exit from Europe didn’t represent a knock-out blow to Europe or the euro. But what pans out in Italy in the months ahead might well be the follow-up blow that does….

That’s a money truth….

I’ll be back with more next Monday.


All the best,


Dave Gibson

Money Truths

P.S. Thanks to all those readers who wrote in with their views on last week’s piece. We like to think of Money Truths as an on-going dialogue – an exchange of ideas and insight. We very much encourage and welcome your feedback and input. You can contact me direct right here.