The Next Exit

| About: CurrencyShares Euro (FXE)


An unknown is the catalyst for an Italian exit.

Coining a new term, "Itexit".

Italian exit implications for the US Dollar.

Most Americans would not know the name Antonio Bedin. Mr. Bedin, a 67 year-old Italian retiree from the Italian town of Montebello, committed suicide. The death, of course, is tragic though you may be surprised at the reason Mr. Bedin took his own life. Another pensioner in the town of Civitavecchia, outside of Rome, hung himself for similar reasons.

In Mr. Bedin's case, his bank, Banca Popolare di Vicenza (BPVi), the 12th largest in Italy, fell under the supervision of the European Central Bank (ECB) after failing stress tests in 2014. It also had to write down €1.333 billion worth of loans in 2015. The bank's capital ratio fell below the 10% threshold set by the ECB requiring it to raise €1.5 billion.

BPVi attempted to raise capital through a stock issuance, though its shares had a very low subscription. An Italian private equity fund dedicated to the recapitalization of Italian banks, Atlante, stepped in to provide the €1.5 billion subscription. Atlante was backed by state lender Cassa Depositi e Prestiti. It mattered not for Mr. Bedin. An investor in the bank since the 1990s, he saw the value of his investment plunge.

BPVi is but one example of the burgeoning Italian banking crisis. Yes, the level of non-performing loans (NPLs) was an issue well before the Brexit, though some may assign fault to the UK's June referendum. One can point to a severe economic decline and underwriting judgment. Italy's GDP peaked in 2008 (we all remember that year) at nearly $2.4 trillion. In 2015 their GDP contracted to $1.8 trillion. NPLs as of the end of 2015 stood at €360 billion.

To add context to the scope of the problem, using a value of 1.2 EUR/USD, Italian NPLs are roughly 24% of the economy. If the problem were the same size in the US, NPLs would stand at over $4 trillion. It will be nearly impossible for the Italian economy to grow its way out of the banking problem.

This is why the specter of a bail-in seems to be taking shape. A bail-in is a bank recapitalization scheme where creditors, including depositors, are tapped.

A common fallacy among bank depositors everywhere is what a bank deposit actually represents. The bank deposit is not a warehouse receipt that one presents at the teller window to reclaim property. A bank deposit is a promise to pay, an unsecured liability. That makes any depositor a creditor to a bank. During a bail-in, you may have no recourse as depositors in Cyprus found out.

Distrust of Italian banks is growing with cash leaving the banking system and stored as physical notes elsewhere. There are also advertisements encouraging Italians to invest in gold bullion. Withdrawing cash and purchasing gold bullion further drains the banking system's capital, essentially becoming a reinforcing loop.

The trouble doesn't end with Italy. Germany, the economic engine of the EU, derives half of its GDP from exports. Given the level of exports to Italy, the banking crisis there threatens to slash German exports and cause other domestic problems. Politically, Germany will have a major problem suggesting to its own that a bail out of Italian banking is necessary, especially after the Cyprian bail-in. Additionally, EU guidelines prevent taxpayers from bailing out beleaguered lenders before other measures are undertaken (i.e.) a bail-in. That said, one of their own banks, Deutsche Bank, could very well represent the greatest systemic risk to the world economy.

On December 4th, Italians will hold a referendum to decide on amending their constitution. Their Prime Minister, Matteo Renzi, is pursuing major structural reforms in the legislative process and has stated he would resign if the referendum fails. If he does resign as promised, it will open the door political turmoil with nationalist parties potentially gaining more power. The parties will no doubt advocate a departure from the Euro. An Italian exit ("Itexit"?) would likely hasten the end of the monetary experiment known as the Euro. Within Italy, secession fears will grow as well.

The implication for US investors continues to suggest a US Dollar strengthening versus the Euro. This is a position I have advocated for some time as demonstrated through an investment in RYSBX. While some have raised alarm bells at the recent inclusion of the Chinese Yuan in the Special Drawing Rights (NYSE:SDR), that does not mean the end of the Dollar, yet, as the world's reserve currency. The implosion of the Euro, one of the currencies represented in SDRs, will only strengthen those that remain.

The death of Antonio Bedin could be a watershed economic moment for the end of the EU, an uber-government creation of political leaders for the benefit of political leaders.

Disclosure: I am/we are long RYSBX.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.