The Phaserl


In Bleak Prognosis, Italy’s Financial Regulator Threatens EU with Return to a “National Currency”

by Don Quijones, Wolf Street:

Because Italy’s banking crisis and other problems have not been solved.

Nerves are fraying in the corridors of power of the Eurozone’s third largest economy, Italy. It’s in the grip of a full-blown banking meltdown that has the potential to rip asunder the tenuous threads keeping the European project together.

In his annual speech to the financial market, Giuseppe Vegas, the president of stock-market regulator CONSOB — a consummate insider — delivered a bleak prognosis. The ECB’s quantitative easing program has “reduced the pressure on countries, such as ours, which more than others needed to recover ground on competitiveness, stability and convergence.”

But it hasn’t worked, he said. Despite trillions of euros worth of QE, Italy has continued to suffer a 30% loss in competitiveness compared to Germany during the last two decades. And now Italy must begin to prepare itself for the biggest nightmare of all: the gradual tightening of the ECB’s monetary policy.

“Inflation is gradually returning to the area of the 2% target, while in the United States a monetary tightening is taking place,” Vegas said. The German government is exerting mounting pressure on the ECB to begin tapering QE before elections in September.

So, too, is the Netherlands whose parliament today treated ECB President Mario Draghi to a rare grilling. The MPs ended the session by presenting Draghi with a departing gift of a solar-powered tulip, to remind him of the country’s infamous mid-17th century asset price bubble and financial crisis.

For the moment Draghi and his ECB cohorts refuse to yield, but with the ECB’s balance sheet just hitting 38.7% of Eurozone GDP, 15 percentage points higher than the Fed’s, they may ultimately have little choice in the matter. As Vegas points out, for Italy (and countries like it), that will mean having to face a whole new situation, “in which it will no longer be possible to count on the external support of monetary leverage.”

This is likely to be a major problem for a country that has grown so dependent on that external support. According to the Bank for International Settlements, in 2016, international banks in particular those in Germany reduced their exposure to Italy by 15%, or over $100 billion, half of it in the last quarter of the year. ECB intervention helped plug the shortfall, at least for a while. But the ECB has already reduced its monthly purchases of European sovereign debt instruments, from €80 billion to just over €60 billion.

As the appetite for Italian government debt falls, the yields on Italian bonds will rise. The only market participants seemingly still willing and able (for now) to increase their purchase of Italian debt are Italian banks.

Over a two-month period, Italian banks increased their holdings of Eurozone government debt by €20 billion, with €12.3 billion of newly conjured funds poured into Italian debt alone, according to a joint study by the ECB and Jefferies International. It’s the highest increase since 2015, bringing Italian banks’ total holdings of Italian government debt to an eye-watering €235 billion. When rates begin rising on that debt, those same banks, many of which are already verging on insolvency, will begin bleeding new losses.

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