He's Baaack: Berlusconi's Return Is The Wind Beneath Short Sellers' Wings

Includes: EWI, GLD, UUP
by: Kyle Spencer

A few months ago I finished The Sack of Rome, Alexander Stille's exhaustive and exhausting chronicle of political party Forza Italia (literally, "Go, Italy!") and its founder, CEO, and Chairman, former Italian PM Silvio Berlusconi.

It's okay if you haven't read it. For those of you who have watched Francis Ford Coppola's The Godfather, just imagine that Don Corleone rewarded Johnny with a television station instead of a movie deal, and you've nailed Berlusconi's life story cold.

Fig. 1: Silvio Berlusconi: Not quite Julius Caesar, not quite Benito Mussolini, 100% Italian owned and operated.

Berlusconi's sudden resurgence says something profound about the devil-may-care attitude of a significant portion of the Italian electorate. Fiddling while Rome burns has happened often enough throughout Italian history for it to be part of the Italian brand. Just to give you a sense of scale, the Wikipedia entry "Trials and allegations involving Silvio Berlusconi" has twenty-two subsections.

This is the guy who's political coalition has just taken the Italian Senate.

Lords of Austerity

With the Italian government now effectively paralyzed, with neither the centre-left nor the centre-right carrying a majority in the Senate, it is forcing Italians to go back to the polls yet again. In the meantime, bondholders are hoping that the Italian parliament will tweak Italy's election laws in order to deliver a decisive majority to former Communist Pier Luigi Bersani.

Such heavy handed tactics threaten to play directly into Berlusconi's hands by feeding the prevailing narrative that Berlusconi is being penalized by the "lords of austerity." In the eyes of a large swathe of the Italian electorate, Saint Berlusconi is the victim, as illustrated by pro- Forza Italia lego arrangement in Figure 3 below.

Fig. 2: Italy's former Prime Minister, Berlusconi, prosecuted by, as he himself said, "three communist feminist female judges".

Papi's Tax

Not only is Berlusconi's return to the world stage a fantastic short term development for gold (NYSEARCA:GLD), "papi's tax" - the price Italian voters will have to pay on the international markets if they return Berlusconi to power - is also a blessing for short sellers in general.

According to Tito Boeri, Professor of Economics at Bocconi University, Italian bonds spreads widened nearly every time a member of the Berlusconi administration opened his mouth.

Fig 3: Difference in Italy-Spain spread (in relation to the German 10 year bund). Positive values indicate that Italy's spread is higher than the Spanish one.

(Source: http://www.voxeu.org)

The first thing to notice is that Italy's relative position worsened dramatically after Giulio Tremonti, under pressure over a corruption scandal involving his main advisor at the Ministry, stated that he himself was the only politician that could resist pressures for increased public spending: "The political attacks against me are an attack against the country". This is shown as point 4 in black. This was the worst signal one could possibly convey to markets. A minister caring for market sentiment should have immediately reassured investors about the political turmoil in which he was involved by stating that public finances would be under control regardless of his private situation.

Of particular note is the August 3rd event, marking Berlusconi's speech to Parliament on August 3rd. As Boeri notes:

It had been touted beforehand as a groundbreaking speech, but proved to be void of any new or relevant information for investors. During a credibility crisis, an empty speech is worse than no speech at all. The decision to close the Parliament for six weeks (including a study tour of Italian MPs to Jerusalem), in the middle of the financial storm, just while José Luís Zapatero had announced his intention to spend the entire month of August in Madrid, marked another increase of the relative spread, as it was interpreted as a signal that the Italian government was trying to procrastinate the fiscal adjustment.

All these events moved the relative spread in the direction that one could have expected a priori.

Berlusconi offers the Italian people an alternative to austerity. It's a chimera, a dangerous fantasy, and ultimately fatal to Southern Europe, but so what? "They wouldn't dare cut Italy off!", Berlusconi thinks, and the truth is, he may be right.


Debtors don't love their creditors. The assumption that austerity without end would be tolerated without end in the name of shared sacrifice, and that the Italian people would be appropriately grateful is a curiously modern banker's fantasy. Certainly, no Renaissance moneylender entertained such vain delusions about human nature. In Shakespeare's A Merchant of Venice, Shylock is portrayed as a villain who is cheated out of a perfectly legitamite business contract based upon a semantic technicality.

Investors looking to profit from Mr. Berlusconi's return to the world stage may find plays which favor a strong U.S. dollar preferable to shorting Europe, as Japanese Prime Minister Shinto Abe stocks up on U.S. debt in order to devalue the yen. The most prominent of these is, of course, the PowerShares DB US Dollar Index Bullish ETF (NYSEARCA:UUP), which measures the performance of the greenback against the euro, yen, British pound, Canadian dollar, Swiss franc and Swedish krona.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.