Four Possible Outcomes to Italy's 5-Star Mess

By: Adrian_Ash

Alessandra Pilloni writes: Rome will have a new pope before Italy gets a new government. Good job there's no rush...

ROME has now been without a government since mid-December. Italy's politicians will only start to talk later this week about doing something about last month's failed elections. Barely a month after Benedict XVI resigned, the Catholic world will have a new pope before Italy gets a prime minister. It's lucky there is no rush.

Italy's debt was downgraded on Friday by the Fitch ratings agency. Interest rates have already risen further since then. Rome goes back to the bond market to raise new finance this Wednesday. Yesterday meantime brought a cut to the GDP figure reported for end-2012, now shown shrinking by 0.9% from three months earlier.

Can Italy shake itself out of this mess? Apparently at opposite ends of the political spectrum, both Beppe Grillo and Silvio Berlusconi have catalysed discontent with European politics, very often blaming the Euro as ultimate responsible for the crisis. But what would happen if the political programme of Grillo's 5 Star Movement came to reality, and more specifically if Italy decided through a referendum to leave the Euro?

What if the Italian debt was restructured? And if these hypotheses don't become reality, which scenarios are likely to take place instead?

#1. Italy chooses to leave the Euro
Returning to the Lira would mean that private savings would be redenominated in the old currency (well, a new currency with an old name), and be devalued. Savers would get poorer in real terms, losing purchasing power overnight. After all, going back to the Lira would be chosen exactly because it gave monetary sovereignty back to Italy. And what tradition could be more Italian than  devaluing the Lira?

But this leads to the next question: would the 'old' public debt be redenominated as well? It seems unlikely, as creditors would not accept such a loss in real terms. The consequences of having a public debt denominated in Euro while devaluing the Lira are easy to imagine.

#2. Restructuring the public debt
Restructuring debt is normally a consequence of a default. Letting Italy reach that stage would clearly present a hazard to all Eurozone states. But cutting interest rates on bond contracts that have already been agreed would also be a heavy blow for Italian banks, and for households too. Because 63% of the public debt is owned domestically. Consequently, Italy  would have a hard time trying to finance new debt after stinging its own citizens, most especially if it had just quit the Euro and lost the support of the European Central Bank.

#3. Italy muddles through
If Italy both stays in the Eurozone and avoids the extreme measure of debt restructuring, it seems unavoidable that the austerity of the past few months would continue. Italy could still finance its debt, with a little help from the ECB if needed. But only with some strict conditions, of austerity plus growth.

We'll leave to the reader's discretion whether austerity and growth can be used in the same sentence. But it is certain that the pain heaped on voters by "muddle through" would leave Italy repeatedly exposed to fresh debates over leaving the Euro or restructuring the public debt. Only, with the pain growing worse, the element of "choice" could be removed – making Euro exit and creditor losses an extreme but inevitable consequence of the failure to address or resolve Italy's deep financial problems.

#4. Italy loses its independence
We'll divide this scenario into two subcategories, one of which may sound familiar to Italian readers at least.

First, there's a potential loss of sovereignty. Because extreme situations require extreme measures. The chance of compulsory administration by European authorities can't be ruled out. In fact, and for good or for bad, the appointment of Mario Monti as prime minister to rescue Italy from the brink in autumn 2011 was a loss of national sovereignty.

This is a consequence of community life: many indignities will be permitted to avoid contagion. It seems fair to believe that the recent electoral result exposes Italy to this happening again, with Rome's 16 Eurozone partners imposing their own victor.

Another possibility, and again with loss of sovereignty for Rome, would however be at the extreme opposite of the spectrum. Because it would see the expansion of European monetary and economic unity to include political and fiscal unity as well. This is probably very unlikely to happen in the short term. We know that the punctual German taxpayer is not particularly flattered by the idea. Yet the European Union's own leaders believe it is a possible scenario, and the best. And they after all are in charge for the time being.

With so many politicians trying to take control, is there a way for a private citizen to protect his or her own financial independence and freedom? What we know for sure is that in the last few weeks the Italian phonelines here at BullionVault have started to ring more frequently.

"I'm sure I'm not the only Italian contacting you to buy gold in this situation," says G.F. from Naples, explaining he has decided to invest in some gold to protect his savings in case the Euro collapses or Italy goes back to the Lira. And if the debt crisis worsens and turns unmanageable, who will pay in the end? Not the debtors, that's for sure: they don't have any money. Creditors always pay, and providing the funds they accepted that risk.

Owning physical gold would certainly be a great advantage if either of the first two scenarios above became real. Gold is an international asset, it does not represent a credit, and it is not bound to national or monetary policies. It can't be reproduced or have its value debased at command, nor through a referendum either. Traditionally and in the worst crises, gold guarantees individual sovereignty and financial independence, an autonomy of choice, movement and action.

Yet this crisis insurance has been getting cheaper for Italian savers. Over the past few weeks the gold price in Euros dropped to the same level of November 2011. It is currently around €39,000 per kilo, when just six months ago it reached a fresh record peak of €44,300. Only uncertainty seems to be inevitable in Italy. But anyone interested in taking out insurance against a Euro exit or debt write-down might find it useful to remember that physical gold is not a credit. It can't be restructured. It does not carry default risk.

Alessandra Pilloni

BullionVault.com

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Published novelist and former language consultant Alessandra Pilloni is European operations executive for Italy at BullionVault, the world-leading gold and silver exchange for private individuals. Alessandra's views and comment on precious metals investment are regularly sought by both Italy's mainstream media and specialized blogosphere, among them Il Sole 24 Ore, La Stampa and Panorama.

(c) BullionVault 2013

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