The next domino has fallen...
I recently spent several weeks in Italy, taking the pulse of the country. The Italian referendum on December 4 turned out exactly how I predicted it would.
The “No” vote won in a landslide, with 59% of the vote versus 41% for “Yes,” with a 70% turnout.
The pro-EU Prime Minister promptly announced his resignation after the crushing defeat.
A surging populist party waits in the wings. They're now likely a matter of months away from taking power and then holding a new referendum on whether Italy should dump the euro and go back to the lira.
If that happens, Italians will likely vote to leave.
Without Italy, the euro currency would likely disintegrate. Without the euro, the whole European Union—the world's largest economy—would likely come unglued.
Italy’s referendum is likely just the first of many dominos to fall.
Here are the ones that will come next…
A Banking Crisis
The Italian banking system is a mile-high house of cards.
It’s looking wobblier every day.
The triumph of the “No” side will also accelerate the crises in the Italian banking system, which was already on the verge of collapse.
The collapse now appears imminent. It could start as soon as this weekend.
Banca Monte dei Paschi di Siena (BMPS) will likely be the spark that sets it off.
BMPS—Italy’s third-largest and most troubled bank—is likely to announce in the coming days whether it has successfully raised enough capital to remain solvent. My view is that this would be highly unlikely.
If the capital raising efforts fail, there’s only one way to keep BMPS—and the entire Italian banking system—from collapsing… a bail-in.
A bail-in would have a catalyzing effect, like political nitroglycerin. If and when it happens, expect support for anti-euro Italian populist parties to skyrocket.
The Super Bubble in Italian Government Bonds Will Burst
Italy has one of the most indebted governments in the world. It’s borrowed over $2.4 trillion, and its debt-to-GDP ratio is north of 130%. (For comparison, the US debt-to-GDP ratio is 104%.)
But the situation is actually much worse.
GDP measures a country’s economic output. However, it’s highly misleading. Mainstream economists count government spending as a positive when calculating GDP. A more honest approach would count government spending as a big negative.
In Italy, government spending accounts for a whopping 50%-plus of GDP. A more accurate debt-to-GDP ratio would exclude government spending from economic output. I suspect that figure would reveal the Italian government’s hopeless insolvency.
I don’t see how it’s possible for the Italian government to extract enough in taxes from the productive part of the economy to ever pay back what it’s borrowed.
Yet Italian government bonds are trading near record-low yields.
It’s a bizarre and perverse situation.
Over $1 trillion worth of Italian bonds actually have negative yields. That’s completely insane.
Given the huge risks associated with lending money to the bankrupt Italian government, the yields on Italian sovereign bonds should be near record highs, not record lows.
With the failure of the referendum I expect that the Italian government bond super bubble has now found its pin.
This means there are two possibilities…
First, the European Central Bank will have to put the printing presses into overdrive to accelerate its program to buy Italian government bonds. It will also create an incentive for other governments to be reckless, assuming the ECB has their backs. This, of course, will hurt the value of the euro.
The alternative is that the Italian government will have to acknowledge its bankruptcy. This would humiliate the mainstream parties and vindicate the populist parties, which have made defaulting on Italy’s unsustainable debt one of their planks.
Either outcome is very bad news for the Eurocrats.
Other Key European Elections
A populist tsunami is washing through Europe. It will drastically change the Continent’s political landscape in a way not seen since before World War II.
This wave will flush away traditional “mainstream” parties and usher in anti-establishment populists who want to leave the euro currency and the European Union.
It’s already hit the UK in the form of Brexit, killing David Cameron’s pro-EU government in the process.
It struck Italy earlier this week, washing away pro-EU Matteo Renzi.
The momentum is clearly building for this anti-elite surge. It’s like a hurricane gathering strength. I think the failure of the Italian referendum is the tipping point. It will make this trend unstoppable.
Voters in Europe’s biggest countries could soon throw out their “mainstream” parties in favor of populist and Eurosceptic alternatives.
2017 will be a decisive year.
Voters go to the polls in major elections in the Netherlands (March 15), France (April 23), and Germany (between August 27 and October 22).
Anti-euro populists have a real chance to win in any of those countries. If they win in even one, the EU would likely unravel.
The Bottom Line
My thesis for the collapse of the EU is getting stronger and stronger.
We're now much closer to seeing - as one Italian politician recently put it - the euro melt away like a gelato left out in the August sun. I think the failure of the Italian referendum marks the beginning of the end for the currency.
I expect the euro to tank soon.
If it breaks below its March 2015 low of $1.046, it would pave the way for it to test parity with the US dollar (which hasn't happened since late 2002). If that happens, look out below.