Italy’s ascendant populists on Left and Right have shelved their immediate plans to leave the euro. They are plotting instead to subvert monetary union from the inside with parallel currencies and deficit spending in open violation of the Maastricht Treaty.
This is equally dangerous for Germany and for the political construction of Europe, and is far more likely to happen.
The rebel forces jockeying for power in the elections on March 4 currently lead the polls by a wide margin. Between them they command two thirds of the electorate. All view the euro system as a racket run largely in the interests of Germany. They intend to fight back by gaming the EU themselves with matching cynicism and Machiavellian "astuzia".
The eurosceptic revolt should come as no surprise. Economic recovery in Italy is a relative term. Output is still 6pc below the pre-Lehman peak. The tangible reality for most Italians is even worse since real disposable income per capita has not yet returned to the levels of 1995, when the lira was fixed in perpetuity against the D-Mark. A quarter century of depression explains why the pro-European centre is withering on the vine.
The rebel Five Star Movement of comedian Beppe Grillo – Italy’s "Pirate Party" – leads the latest Tecne poll as the biggest party at 28pc. The Right-wing coalition of Forza Italia, Lega, and the Brothers of Italy is the biggest bloc at 38pc, under the smiling embrace of Silvio Berlusconi – banned from public office for tax fraud but ever present.
Nobody knows what will emerge from the splintered landscape – other than a hung parliament – but the thrust of policy is clear: “All of the economic proposals discussed ahead of the elections point in one direction: a sharp increase in public deficit,” said Mauro Baragiola and Tina Fordham from Citigroup.
“Austerity is going to stop completely, because if it doesn’t stop, the Italian economy will die,” said Claudio Borghi, the Lega’s economics chief. “We are not Greece: we are a much bigger country, and we are net contributors to the EU budget, so how is Brussels going to stop us?”
For the last six years Italy has been governed by leaders broadly willing to uphold the EU agenda, firstly during the austerity overkill of ex-EU commissioner Mario Monti, parachuted into office after the so-called “coup d’etat” when the European Central Bank used its control over Italy’s bond spreads to topple Mr Berlusconi.
It continued under the putative Wunderkind Matteo Renzi, who burst on the scene vowing to drag Italy kicking and screaming into the 21st century. Nothing much came of Mr Renzi’s theatrical energy – a warning for his French political twin, Emmanuel Macron.
Italy is still placed at 79 on the Heritage Foundation’s scorecard of economic freedom, or at 46 on the World Bank’s "ease of doing business" list. “Efforts to narrow Italy’s competitiveness gap with its peers have not yet succeeded. While several implementing decrees have been issued, key actions have effectively stalled,” said the International Monetary Fund.
Yet at least Mr Renzi broadly played the EU game by EU rules, as does the current Gentiloni government. It is this acquiescence that can no longer be taken for granted.
Italy’s eurosceptic parties learned the lesson of Marine Le Pen’s campaign flop in France last year. However much voters dislike the euro, they fear the trauma of outright rupture even more. Mr Berlusconi tweeted that the euro is a deformed currency that has pauperized Italians but it is “technically impossible” to leave.
Yet the Right’s joint manifesto makes it clear that they will not abide by the terms of euro membership either. It includes the creation of zero-coupon Italian treasury notes to pay €30bn (£26bn) of arrears owed by the Italian state, mostly to contractors. The bills would be accepted by the Italian state in lieu of taxes or to purchase goods from state entities such as fuel from oil giant ENI. It is a way to flout the deficit ceiling.
The notes would circulate as a means of exchange outside the ECB’s control, and could expand over time to finance investment projects. “If people say this looks very like a parallel currency, who am I to disagree?” Mr Borghi told me with mischievous relish.
The view in Rome is that the Bank of Italy’s €454bn liabilities to the ECB through the internal Target2 payments system – caused by slow capital flight – are now so large that they have become Europe’s problem. If Italy were ever to walk away from the euro and cover its Target2 liabilities by printing new lira, the effective default would trigger an epic crisis for monetary union.
This shadow currency is roughly what Yanis Varoufakis wanted to do at the height of the Greek crisis in 2015, but was blocked the country’s "war cabinet". It is technically easy. California used such notes as temporary liquidity after the Lehman crisis in 2008. But if Italy took this course today, it would subvert the ECB’s control over the money supply and rapidly destroy German consent for the euro project.
The Berlusconi coalition plans a flat tax (from 15pc to 25pc) to jump-start the economy. It pledges to reverse Mario Monti’s pension reforms. It has floated a minimum "dignity income" of €1,000 for every citizen. This all implies massive deficit spending.
For good measure, it will pass legislation stipulating that the Italian constitution must have primacy over EU law, equipping Italy with the sort of legal argument deployed by the German Constitutional Court in Karlsruhe – although Germany has never actually struck down an EU law. It knows that the EU would become unworkable once one country did so.
On the Left, Five Star’s executive leader, Luigi di Maio, has dropped plans for a euro referendum, arguing that the time for "Italexit" is not yet ripe. The vote should be kept as a last resort, a bargaining chip to force Europe to accept sweeping treaty changes. He vows to tear up the 3pc of GDP rule on budget deficits, and pledges a budget-busting basic income of €780.
Italy has no safety margin for such largesse or for the exploding deficits that would follow. It has taken nine years of the global expansion merely to stabilize the public debt at 133pc of GDP, when it should be falling hard. The IMF says the structural primary deficit has worsened by 2pc of GDP since 2014 when adjusted for the cycle.
While growth picked up to around 1.5pc last year, it is too little for a country with a large lingering output gap. Other laggards from the EMU debt crisis have seen much stronger catch-up recoveries, the fruit of less rigid labour and product markets. The danger is that Italy will run of road before the next global downturn hits.
All this is happening just as the ECB prepares to halt its bond purchases – already down to €30bn a month – and leaves Italy nakedly exposed to the markets. Rome must refinance debt worth 17pc of GDP next year without obvious buyers. Italian banks have been systematic sellers.
Europe’s economic commissar, Pierre Moscovici, says Italy is like a cat: it always finds some way to land on its feet. The global boom may last long enough to lift the country off the reefs. Hung elections may throw up another technocrat government that buys more time. Yet it is hard to avoid the conclusion that the EU is close to losing Italy. The emotional cord is broken.
Europe dodged a bullet in the first round of the French elections last year when 48pc issued a cri de coeur that was in large part against the EU system. The next test may be harder to handle.
