Thread by @KellerZoe

Draghi ushers in the counter-revolution but he can’t save Italy. Those in EU circles and the bond markets celebrating this insider riconquista should be careful what they wish for — AEP
telegraph.co.uk/business/2021/…

Italy has gone through the gears, from a democratic revolt against the € and the country’s pro-EU elites, all the way to the other extreme of a technocrat government under the ultimate Mr Euro, without any election along the way.

The stitch-up has been breath-taking. The appointment of Mario Draghi to navigate the dangerous waters of the next two years is astute but EU circles and bond markets celebrating this insider riconquista should be careful what they wish for.

The last usable card has been played in Italy’s misadventure with monetary union, a regime that has led to two lost decades of perma-slump, overseen 50% youth unemployment rates across the Mezzogiorno, and culminated in a debt-deflation trap. It had better work.

3 years ago, Italian voters rebelled against this regime. Insurgent parties of Left and Right swept into power, vowing to defy EU fiscal rules and to reverse reforms imposed upon them (indirectly) by Berlin. A ‘mini-Bot’ parallel currency was written into the coalition agreement.

This twin-headed hydra was never going to work. The techno-utopian anarchists of the 5S and their mad “Guarantor”, Grillo were joined with Lega nationalists under the Milanese strongman Matteo Salvini.

The clueless Five Star were tamed and co-opted.
Or seen from Brussels, they ‘matured’, like Syriza’s deflated rebels in Greece. Step by step, Italy’s vested interests reeled back the core ministries.

The counter-revolution is now complete. The country is being placed fully under a disguised Troika to ensure that EU payments from the Recovery Fund are not misused for patronage, and therefore to ensure that northern paymasters allow the money to flow.

This episode is more ambiguous than the institutional coup against Berlusconi (defenestrated in 2011 after he threatened to take Italy out of the €). Then a former EU commissioner, Monti, was installed in charge. The experiment failed. It led to the Lega-Five Star backlash.

President Mattarella is within his constitutional rights to turn to another Mario, this time from the European Central Bank. But all Italy knows that this is a last-ditch manoeuvre to avert elections.

A vote today might lead to a very unwelcome outcome for the poteri forti, the mandarins and bankers behind the scenes who pull the strings of the permanent government. The Lega and the Right-wing Fratelli d’Italia are together running at 40.5pc in the latest TECNÈ survey.

This would give them a shot at an outright majority in parliament, even without Mr Berlusconi’s Forza Italia. The Lega is not as fierce as it once was, but nor has it been ideologically co-opted. It still has a proto-lira in its back pocket.

Draghi is a shrewd operator. He rescued the euro after it was almost destroyed by the serial errors of Trichet: a panic rate rise in the early stages of the global financial crisis in July 2008; and premature tightening measures afterwards that set off the sovereign debt crisis.

The MIT-trained Draghi moves in economic circles far above such monetary provincialism. He recognized the dangers of a structural slump. His skill was to herd the cats of the ECB’s governing council, preventing open dissent as he pushed QE on epic scale

But the € was not saved by a “whatever it takes”. It was saved by Merkel: she belatedly recognised it was politically less dangerous to let the ECB buy bonds. Once this decision was taken, the debt crisis faded away. Four years of misery had been entirely avoidable.

Nevertheless, Draghi failed in the end. The deflationary damage was too deep. QE came too late to avert Japanification. His policies left the sovereign-bank ‘doom-loop’ worse than ever.

But he did succeed in drawing Germany into the Faustian Pact. The side-effect of QE has been a vast imbalance in the ECB’s Target2 system. Southern central banks have built up liabilities of €1 trillion to the ECB system, implicitly to the BuBa. Germany can never pull the plug.

Assuming Draghi is able to form a government, he faces an invidious task. The pandemic has lifted Italy’s debt ratio by 33 points to 160% of GDP since March, and the virus is not defeated yet. EU’s vaccine travails have pushed out recovery by a further 3 months.

Italy may lose the first half of this year’s tourist season on top of last year’s. The longer this goes on, the greater the subsequent cascade of corporate insolvencies

The €750bn Recovery Fund has been oversold by Italy’s leaders. "The idea that billions will soon be flowing is propaganda. The recovery fund is not going to change anything," said Claudio Borghi, Lega chairman of the budget committee.

The net fiscal transfer to Italy amounts to 0.7% of GDP annually stretched over 3 years. It is a modest nudge of the macro-economic needle.

“We do not see it as a historical agreement heralding a re-foundation of the EU or the euro area,” said Citigroup’s Arnaud Marès, Draghi’s former right-hand man at the ECB. “Rather than a game changer, we see it as another example of the same game that has prevailed under Merkel.

Whenever the cohesion of the EU faces clear and present danger, European governments agree to the minimum demonstration of unity to keep the risk of break-up at bay.”

Draghi can lend credibility to Italy’s spending plans, making it easier for the German bloc to agree to a bigger Recovery Fund later. He can activate the ESM for precautionary loans, creating an extra safety buffer for the day when the ECB has to stop buying Italy’s debt.

But all this buys only time, cannot rescue Italy from a bad equilibrium, consequence of a quarter-century with the wrong exchange rate. Draghi’s govt will probably fall within months. If it survives, there will be elections within 2 years the eurosceptic Right will probably win.

Should he hang on longer, the debt mountain casts its gigantic shadow.
The man who has spent his public life trying to get Italy into the €, and keep it there, might by a twist of fate become the man who has to oversee the purgative exit. He would be perfectly suited to the job.