Could Italy Really Leave The Euro?

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Includes: ADRU, DBEU, DBEZ, DBIT, DEZU, EDOM, EEA, EPV, EURL, EWI, EZU, FEEU, FEP, FEU, FEUZ, FEZ, FIEE, FIEU, FLEE, FLIY, GSEU, HEDJ, HEWI, HEZU, HFXE, IEUR, IEV, PTEU, RFEU, UPV, VGK
by: Discount Fountain
Summary

As it stands, Italy does not necessarily wish to leave the euro of its own volition.

However, Italy's debt crisis could be a major problem for the eurozone.

Should Italy default on its debt, then this has the potential to trigger a significant decline in global growth.

For this reason, I am watching the situation in Italy very closely.

Ever since a new parliamentary government took power in Italy at the beginning of June, there has been increasing speculation as to whether Italy could leave the euro.

However, does this concern simply make for a good media story, or is there actual credibility behind it?

It is no secret that of all the EU countries, Italy has been particularly badly struck by the previous financial crisis. Where countries such as Greece had to contend more with a crisis relating to government debt, the crisis in Italy has been banking-related as well. Across Europe as a whole, $938 billion of bad loans still remained on the balance sheets of European banks, with a large portion of these coming from Italy.

It has been speculated that the world’s next financial crisis – if there is one in the near future – could indeed be triggered by Italy.

While the eurozone has started to see growth as a result of quantitative easing, this has not necessarily applied in Italy. GDP growth has struggled to stay above 0% since 2014:

Source: tradingeconomics.com

Moreover, we see that even with an era of low interest rates in Europe, loans to the private sector have continued to see a long-term downtrend, and bankruptcies as a whole are a lot higher than they were 10 years ago.

Loans to private sector

Source: tradingeconomics.com

Bankruptcies

Source: tradingeconomics.com

So, what precisely would leaving the euro mean for Italy, and would the benefits of doing so outweigh the costs?

Firstly, if Italy leaves the euro and decides to reintroduce the lira, it is likely that we would firstly see a big devaluation relative to the euro. The reason for this is that the Italian central bank simply would not have the credibility of larger institutions such as the ECB in combating inflation. Therefore, the result would most likely be a devalued currency along with sharply rising inflation.

Indeed, a major reason for Italy wanting to join the euro in the first place is due to the lira having lost over 80% of its value relative to the German mark between 1970 and 1999. At the time, joining the euro was seen as the only way to counteract the effects of devaluation.

However, while a populist government is now in power in Italy, the country is not necessarily intent on leaving the eurozone. Di Maio, the Labour and Industry Minister and Deputy Premier recently stated:

“The government does not want to quit the euro. I don't know if others will try to kick us out, but that is not what we want and we won't put others in the condition to be able to do so."

With this being said, if Italy does leave the euro – this will lead to very significant hardship for the eurozone and could indeed be a catalyst for a worldwide recession.

Italy’s debts to the European Central Bank are set to hit €500bn this summer, and the Italian government’s debt of €2.5 trillion is larger than that of Spain, Portugal, Greece, and Ireland combined.

Therefore, it would not be possible for the ECB to provide Italy with the type of assistance that it provided to other countries, and the central bank would sustain large losses if Italy did indeed default. If this were to happen, then it would frankly be of little consequence for Italy whether the country stayed in the euro or not – it is the eurozone itself that would likely have the most to lose in this situation.

In my opinion, I don’t – as of yet – see a situation where Italy would choose to leave the eurozone of its own volition. However, if Italy’s debt load ends up becoming unsustainable and the country does default, then the country may not have another option. If this were to happen, then the global ramifications of such would be very severe. For this reason, I take the view that developments in Italy should be at the forefront of investors' minds right now.

Disclosure: I/we 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.