Ray Dalio: Unity Behind The Leader Or Internal Fighting? The Mario Draghi Case

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The case at hand is that of Mario Draghi and Italy. It’s “another one of those” classic cases in which a country’s lack of discipline and fragmented leadership have led to a combination of 1) excessive debts and 2) a lot of internal conflict. Italy is also in 3) a big external conflict relating to the Ukrainian-Russia war. Together these forces make Italy vulnerable to a debt/financial crisis and de facto anarchy. In my template for a cycle of internal orders and disorders set out in Chapter 5 of my book, Italy classically is in stage 4 of the cycle. This case isn’t just interesting in how it will affect Italy, Europe, and beyond, it exemplifies how such cases generally transpire. It gives you and me the opportunity to watch an iconic case in action. It is also, in my opinion, a “canary in the coal mine” case, meaning that what happens in this case will exemplify how the cause-effect relationships work at this stage in the cycle, which will be broadly indicative of what might happen in other cases of countries in this stage of the Big Cycle.

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Mario Draghi's Leadership

Enter Mario Draghi: Will the Italians Choose A) Smart Bipartisan Leadership That Will Require People with Different Perspectives to Not Get Exactly What They Want, or B) Dysfunctional Fighting for Exactly What They Want?

In this case, 18 months ago Mario Draghi became prime minister because dire circumstances and dysfunctionality of the political system made it clear that supporting a capable non-partisan leader was smarter than the dysfunctional fighting that was going on. Draghi accepted this job on the condition that he would have non-partisan support. This was both a noble and a practical decision. It was noble because only a hero or a lunatic would accept that job, and Draghi is no lunatic. It was practical because he and the whole effort would fail without non-partisan support. It is now the case in most democratic countries, especially the United States, the choice is between A) becoming more unified in supporting a smart bipartisan leader, which would require people with different perspectives to not get exactly what they want but will give them more compromised outcomes in which the system remains intact and works better, or B) dysfunctional fighting for exactly what they want which will give them ineffective decision making and a greater risk of some kind of civil war. 

Over the 18 months that Draghi was in his job, the world changed; most notably central banks created a lot of money and debt, the war in Ukraine came, inflation accelerated, and the ECB's free money policy proved inconsistent with its mandate to control inflation, so it's preparing to start to raise interest rates in a tiny way. At the same time, everyone knows that raising interest rates will hurt Italy's and other big debtors' abilities to service their debts, leading them to raise their interest rates further which could cause a debt and currency crisis. This dynamic is always the case and is the present case for many other countries, so how Italy's case transpires will be instructive and representative for considering how other cases will go. If you're interested in reviewing this classic dynamic, it is covered in my book Principles for Navigating Big Debt Crises which you can have for free here or in book form here. In my opinion, we are clearly in phase 3 of the classic Big Debt Cycle when the central bank faces the choice between a) allowing money and credit to tighten and interest rates to rise, which is depressing especially for those most over-indebted, and b) printing money to help the most indebted service their debts and keeping real interest rates artificially low, which devalues their money, heightens inflation, and increases debt, which makes the problem worse down the road. Most everyone in Europe is now operating on a version of this second path which will require a lot of cooperation, especially from the Italians. They refer to it as the “transmission protection" or the “anti-fragmentation” mechanism. Draghi is especially capable and well-positioned to deal with this and most people agree that Draghi has done an excellent job, e.g. he has the highest approval rating in the G7 at 47%.

The Shift Away from the Unity Behind the Leader Toward More Internal Fighting.

Despite these good reasons to support Draghi, last week the second largest political party in Italy (the Five Star Party) pulled out of the coalition supporting him and Draghi sensibly said that he will resign without the unity of support. Resigning makes sense even though it will make matters worse for Italy over the short term. That's because history and logic make clear that being a leader of a country in which the people are hell-bent on fighting with each other and tearing down bipartisan efforts is pointless. It's like trying to fight the tide. One might as well stand aside and let what will happen happen, including having the terrible outcomes under someone else's leadership. One way or another there must come about a greater appreciation for a smart strong leader who tries to help most of the people, rather than a leader of one faction in a battle with others.

History and logic make clear that in a democracy in which there are both 1) weak fundamentals that are leading to painful circumstances and 2) fragmentation in political decision making, one is destined to be a failed leader. That is because at such times the only leadership that will work is smart enough and strong enough leadership that can make the needed changes to deal with the fundamental problems well.

This week two votes of confidence are scheduled - one in the Senate and the other in the Chamber of Deputies. Of course, it would be best if he gets strong expressions of confidence and the non-partisan coalition holds because Draghi is capable and widely respected by both international investors and most factions within Italy. I personally believe that he is exactly what Italy needs now, because the alternative picture of what it will get without him is a bleak one. We will see. However, even if the vote of confidence is given and Draghi stays, it appears that with this level of indebtedness, political fragmentation, the need for monetary policy tightening, and the likelihood of painful structural reforms being required to create a deal for protections to be put in place against Italian interest rates rising a lot against less indebted countries’ interest rates, it seems unlikely that this will go well for long, especially given the longevity of the average Italian leader being what it is. But it’s worth the try.

The classic biggest risk to democracy comes when there are bad conditions and great fragmentations about what to do about them. That often leads to some form of anarchy and civil wars that inevitably lead to the rise of autocratic leadership that takes control of things to "make the trains run on time." Italians should know this very well. Can Mario Draghi's capable non-partisan leadership prevent this? An objective observer would bet against it because it's very rare that a country that is so challenged and fragmented chooses to follow the capable leader without continuing to fight with each other and the leader.

This is an Iconic Case; Pay Attention to the Others.

While this case involving Mario Draghi, Italy, and Europe is particularly interesting and precarious because Italy is so overly indebted, politically fragmented, and the central bank needs to raise interest rates (because they are extremely low relative to inflation) which will be very painful, Italy is just one of a number of countries in this position. History has given us many lessons about how these situations play out. The next interesting challenge of this sort to watch is Brazil's.

Now Most Leaders in Democracies Can't Lead.

As I said earlier, trying to lead when people are hell-bent on fighting with each other is like trying to prevent the tide. One might as well stand aside and let the terrible consequences come. I think that is now true in most countries. What is needed in times of difficulty and fragmentation is strong leadership that fixes things. History and logic show that that typically only happens after a fight when the winner, who through some mix of suppression of the opposition and giving benefits to supporters to make them happy, gains broad-based support and has capabilities and powers to do the best things for most people in the country. It would of course be so much better if democracies could produce the strong leaders who fix things without having the destructive fighting, but it seems illogical to expect that. Still, it’s something worth striving for.

Article by Ray Dalio via LinkedIn