"A Toxic Coup Narrative": Why Italy's Political Crisis May Be About To Explode

On Friday Europe experienced an existentially terrifying "deja vu" moment straight from the 9th circle of Europe's 2011/2012 sovereign debt hell, when first Italian, and then Spanish, yields exploded amid fears of political chaos in the Eurozone's 3rd largest economy, coupled with the threat of an imminent collapse of the Rajoy government in Spain, the 5th largest economy.

But while Spain is a late entrant to Europe's "political chaos" soap opera - although with both El País & El Mundo calling for an early general election, it is only a matter of time before this particular box of gunpowder also explodes, all eyes remain on Italy where not only have short-term rates blown out to levels that would send MF Global into Chapter 22...

... but the BTP-Bund spread exploded well beyond Goldman's "contagion" threshold of 200bps...

... while the scariest chart of all revealed that Italian redenomination risk is now at an all time high, reflecting the reality of Italy's 'Mini-BoT' parallel currency concerns.

However, if it was the market's intention into scaring Italy's political system into submission, the same way it did in 2011 when the ECB got Sylvio Berlusconi to "quit" in just a few days as Italian bond yields exploded, it has failed, and according to the latest development in Europe, the Italian crisis may be about to get much worse.

Newly appointed Italy Prime Minister Giuseppe Conte

For those who missed it, Italy entered the weekend with the country deadlocked in what may be a Euro-defining clash whether euroskeptic professor, Paolo Savona, strongly endorsed by the League party, is allowed to become the country's next economy minister. Here are the latest troubling details from Leonardo Carella:

The nomination of the designated Finance Minister, Paolo Savona, is being held back by the President of the Republic - a prerogative he formally has but that has rarely been exercised - reportedly over Savona’s anti-EU views.

From President Mattarella’s point of view, Savona, an 82 year-old professor who served in Ciampi and Berlusconi’s administrations, would send the markets out of control and would bring Italy to the brink of open conflict with the EU.

From Lega’s point of view, the nomination of Savona was one of their major wins in the coalition formation game, and the only guarantee of a strong anti-EU slant to government policy, after the coalition contract’s sections on Europe were heavily watered down.

Salvini just tweeted that he is “really angry”. M5S is, for now, supportive of their coalition partner.

This is how a constitutional crisis begins. The possible scenarios now are:

  1. Most likely, President Mattarella gives in under public pressure and threat of a new election. If Mattarella’s worries are correct, we’re in for a rough ride, but the crisis is averted.
  2. If Mattarella and the coalition partners hold firm, we may be set for new elections, with M5S likely to repeat April’s success and Lega likely to increase its share of the votes, eating up Berlusconi’s party.
  3. A very unlikely scenario is that Parliament calls for Mattarella’s impeachment, as per Article 72 of the constitution. However this isn’t likely to bring him down as the Constitutional Court has the final word.
  4. Alternatively, the coalition partners may find an alternative option as Finance Minister. But Lega really stuck its neck out, so it’s unlikely.
  5. Finally, it’s also possible that Lega holds firm and M5S doesn’t want new elections, so that we’re back to the drawing board, with M5S trying to piece together a new majorit

Overall, while Mattarella’s position is constitutionally sound, it’s politically untenable. There are very high expectations on the new govt and a member of the old guard taking (almost) unprecedented action to block them is going to play in the hands of M5S and Lega.

But the most worrying points are: toxic “coup” narrative developing; in the next days, if the crisis worsens, calls for a show of force, for now limited to a few ultras, will grow louder. Plus, Savona’s appointment means Lega is dead serious to face off the EU.

Savona said in an interview that the EU economic model is a continuation of the 1936 Nazi “Funk plan”, whereby Germany would submit the economies of the rest of Europe to its whims, with the only difference that the EU does that via democratic means.

Meanwhile, the oppositions are AWOL.

In conclusion, this developing crisis could be over by next week, if - as I think will happen - Mattarella folds. But then Italy will have a sharply Eurocritical Finance Minister, with all that it entails in the short (market reaction) and long term (open conflict with the EU).

In other words, Italy now finds itself trapped, with the "best", and most likely possible outcome being what the sellside predicted was the worst case scenario as recently as March. As for the worst one, well... buy bitcoin and gold.

Not surprisingly, in an interview with Welt am Sonntag, that admiral of "establishment Europe", and the "euro order", former ECB chief economist, Otmar Issing called on Italian media and politicians to stop bashing the euro, saying that the "Italians are acting now as if they were dragged into the euro against their will so that Germany could force their exports on them. That’s totally absurd."

In his defense of Brussels, and ECB policies, Issing also said that "in one swoop, the Italians got the lowest interest rates since Julius Caesar without doing much for it. They were the biggest beneficiaries and even before the ECB’s zero-interest policy saved untold billions on interest payments."

There is just one problem, of course: those rates were artificial, and the result was an unprecedented wealth transfer from the poor and middle classes, to the rich, which has spurned the anti-globalization movement, which is manifesting itself right now in precisely the policies that will assured the period of artificially low rates end, and explode higher, potentially leading to an Italian default.

But Issing's punchline was straight (counter) propaganda: "Above all, it shocks me with what kind of vehemence it’s being spread in the media that Germany and the euro are responsible for the misery" adding that "I have to admit I’m a big Italy fan. When you consider the potential there is in this country, the development is really a crying shame."

In case it was unclear, this preachy sermon did not help Germany, or the ECB, many any new friends in Italy.

Meanwhile, Savona doubled down on his rhetoric, saying telling Ansa he wants "a different Europe, stronger but fairer" and saying that government action will aim to reduce public debt and deficit not through taxes and austerity, but through growth in GDP by boosting domestic and foreign demand. What Europe heard? "cutting debt."

As for Italy's next steps, we will get an advance preview shortly: Italy's president Mattarella is about to meet with the designated prime minister Conte at 7pm local time; expect things to start moving rapidly shortly thereafter.