The Italian Job

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Brexit Fallout – The Italian Job by Danielle DiMartino Booth, Money Strong

“You’re only supposed to blow the bloody doors off!”

That one line, spoken on the big screen by Michael Caine was crowned, according to a 2003 Daily Telegraph survey, Britain’s favorite one-liner of film. That kind of staying power is remarkable considering The Italian Job, the original that is, was released in 1969, two years before Mark Wahlberg, who portrayed Caine’s character, Charlie Croker, in the movie’s 2003 remake, made his 1971 debut.

As for the film’s American version and one-liners, the crown for favorite was won when Charlie’s 2003 on-screen nemesis Steve taunted: “You blew the best thing you had going for you. You blew the element of surprise.” Charlie’s reaction? A knock-out punch followed seamlessly by the understated comeback, “Surprised?”

The element of surprise was on full display in the hours and days that followed Britain’s voters’ decisive move to Leave the EU. The Brexit referendum succeeded in blowing off a different set of doors, leaving taunting politicians and policymakers alike flat-footed, with a whole new fear, that of contagion, beginning to the south in Italy. Might the Italians pull of a Job of their own, following Great Britain’s lead in stealing back their own country?

The hope, stated diplomatically by Gluskin Sheff’s inimitable David Rosenberg, a dear friend, is that Brexit will prove to be a, “wakeup call for the long-awaited fundamental changes with regards to the EU – make it more democratic and make it less bureaucratic and embark on immigration rules that do not sacrifice regional security.”

Rosenberg’s concerns on security are more than justified in the case of Italy. According to the Italian Coast Guards’ latest tally, the 3,324 migrants rescued June 26 brought the total rescued in just four days to 10,000. Four days! Calm seas have triggered fresh waves of migrants, bringing the total thus far this year to 66,000. The forecast calls for 10,000 more to arrive every week until year’s end. Some 300,000 in total for 2016. The ease with which migrants can cross the seas to Italy means that country takes in 13 to 14 times more than Turkey and Greece. Is it any wonder Italians are exhausted?

At a Brussels Summit, EU leaders were urged to “speed up and increase” the return of migrants deemed to not be bona-fide refugees. In actuality, many making the crossing are simply looking for economic opportunity rather than escaping any real danger. Estimates vary, but only between six and 19 percent of those ordered back to their home countries actually leave. It is patently apparent that the EU does not have sufficient measures in place to combat the problem on behalf of its disgruntled member nations, and must become much more vigilant in its approach.

As economically and culturally debilitating as the migrant crisis has become, it’s critical to take a step back from this particular issue to understand the depth of Italy’s economic plight. The reality is, there’s something greater than just poorly managed migration underlying the unrest in Italy and its EU neighbors.

While the migrant crisis clearly played into Brexit, the vote revealed much deeper anxieties driven by a very visible fact of British life, especially life after the financial crisis. The briefest of visits to the City of London, its streets lined with chauffeured Mercedes, offers ample prima facie evidence of what so many Brits know in their bones – that the distance between “them” and “the rest of us” has grown since the crisis broke.

The average Brit knows they didn’t wake up yesterday ripe to pillory the “elite,” a word that’s crept back into the vernacular like a slowly spreading disease. But they do know they’re not among those who have risen to the creamy top in recent years but have rather been demoted to the ranks of those left behind.

The fairy tale of the wealth effect, that what is good for those at the top of the pecking order is good for the masses, is apparently an international phenomenon. The one saving grace on this count is the British never succumbed to pressure to join single currency. That, however, is certainly not the case for the beleaguered Italians.

Back in the summer of 2012, when Greece appeared poised to leave the EU and escape the euro currency via devaluation of the drachma, Merrill Lynch released a report ranking the countries who stood the most to gain economically from dropping the euro. Can you guess who came in at the top spot?

More than any of its peers, the Italian economy has suffered since joining the euro in 1999. Since 2007, its economy has contracted by 10 percent and suffered not one, not two, but three recessions. Competitive export-led growth has been deeply impaired by virtue of Italy’s being effectively yoked to the massive German economy.

Despite the rise of China, Germany has been able to maintain its top three ranking among world exporters. The secret weapon? That would be the euro. In 1998, the year before Germany switched to the euro, the country exported $540 billion. By 2015, that figure had swelled to $1.3 trillion. Italy’s exports have also grown, but not nearly as robustly, coming in last year at $459 billion compared to $242 billion the year before it joined the euro.

Just as it once was the case with China, Germany benefits from its relatively weak currency. If Germany was not tethered to its weaker-economy neighbors and was still on the Deutsche Mark, it would have a significantly stronger currency and substantially lower exports due to the price of its exports being much more expensive for world markets.

Back in 2011, UBS put pencil to paper and figured that losing the common currency would trigger an immediate effective tax increase for the average German citizen of about €7,000 and between €3,500 to €4,000 euros every single year going forward. By contrast, swallowing half the debt of Greece, Ireland and Portugal at that time would have generated a little over €1,000 tab per citizen. Now you see why bailing out is so easy to do, though the Germans do put on a great show of irritation at having to foot such bills. But let’s be honest. Consider the alternative.

Reverse that effect and, with all else being equal, you begin to appreciate why Italy’s exports have become relatively more expensive, burdened as they are with a more expensive currency than they would have had. Consider that globalization had already done a number on the country’s once magnificent industrial base when Italy opted into the euro and left the lire behind. Since then, the country’s industrial capacity has been further decimated, shrinking by 15 percent. To take but one example, in 2007, Italy manufactured 24 million appliances; by 2012 it had declined to 13 million.

Add up the economic consequences and you begin to understand why Italian unemployment is running north of 12 percent while putting four-in-ten young Italians are out of work. To the Italians, if anyone’s managed to pull off a Job, it’s those smug Germans.

Three years ago, the Merrill report warned that Italy’s current account deficit would be an impediment to returning to the lire in that the deficit required foreign capital to keep current on its bills. Flash forward three years and Italy is running a current account surplus of 1.9 percent, a fairly recent phenomenon and more a reflection of its economic atrophy than a competitive trade position. Nevertheless, that is one obstacle to leaving the euro that’s disappeared.

That is not to say that Italy will be able to ride off into some glowing economic sunset. Italy’s banks are thought to be the Continent’s weakest. There are $408 billion in past due loans sitting on Italian bank balance sheets. Investors value these loans at 20-30 cents on the dollar if they are secured, and as little as 5 cents if they are unsecured while banks have marked them at between 50-65 cents on the dollar.

The yawning gap between market pricing and that of Italy’s banks is reminiscent of how unrealistically Lehman valued its loans before going under. Unicredit, Italy’s largest bank, has seen its stock price halved this year as investors worry its capital is insufficient to handle the Brexit fallout.

Leaving the EU and being unshackled from the euro could well lead to an Italian debt default, which is meaningful given Italy is the third largest sovereign debt market in the world. But local laws also provide plenty of leeway for the government to restructure its debts without triggering a default. The one thing that is not in doubt is that the lire would provide the Italians with the relief they have so desperately needed since joining the single currency.

On the flipside, the damage to Germany’s manufacturing sector could be sufficient to catalyze a Continental recession. Angela Merkel has probably lost considerable sleep being a unified Europe is her treasured baby. In all, Germany’s annual economic growth is boosted by a half-percentage point courtesy of its euro membership.

While there is no denying the economic challenges facing Italy, the potential for its exiting the EU was hugely increased by the Brexit. After all, some 58% of Italians were already calling for a referendum vote. If those voters are angry today, imagine how much angrier they will be if the Brexit throws Europe into a recession that Mario Draghi cannot effectively battle given that he already has his stimulus measures running full throttle.

Tellingly, the anti-establishment Five Star Movement, which has risen rapidly in power in recent months, has not called for a referendum to leave the EU, but rather to get rid of the euro. Beppe Grillo, the stand-up comedian who founded the party said the Brexit, “sanctions the failure of EU policies based on austerity and the selfishness of member States, which are incapable of being a community.” Yes, Stunad, it really is about the economy.

The shame is Italy is its own bureaucratic basket case with little rule of law (think Mafia, tax avoidance and the impossibility of legislating anything from theory into practice). Brexit has lowered the odds Matteo Renzi’s government will stand the test of time and last until October, the date by which his referendum to streamline Italy’s bloated government must be taken up by the Italian electorate.

Even if Renzi stands, Italy’s future in the EU looks to be at risk. The collapse in bank shares in the trading days following the Brexit has created an immediate crisis. Within 72 hours of the vote results, Italy was reported to be preparing a €40 billion rescue of its financial system. A direct recapitalization of the banks, funded by a special bond issue was on the table. But the Italians are also pleading for a moratorium of ‘bail-in’ rules and bondholder write-downs, both of which are prohibited under existing EU laws.

Hate to go out on any limbs here, but odds are pretty good that those rules will be relaxed, all things considered.

How on earth did things go so wrong? Could it be as simple as power-mongering and greed? To rob a line from the 2003 Italian Job, “There are two kinds of thieves in this world: The ones who steal to enrich their lives, and those who steal to define their lives.” Could it be that average working Italians, especially those who have been around for a good long while, feel as if they’ve been victims of both of the two kinds of theft, doubly wronged? “Basta!” their voices scream in defiance. Enough is enough!


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