Authored by Daniel Lacalle via DLacalle.com,
Political risk in Europe was largely ignored in international markets because of the mirage of the so-called 'Macron effect', the ECB’s massive quantitative easing program, and a perception that everything was different this time in Europe added to the illusion of growth and stability.
However, a storm was brewing and the same old problems seen throughout the years in Europe were increasing.
In Italy, the shock came with an election that brought a coalition of extreme left and extreme right populists. Disillusion with the Euro was evident in Italy for years, as the economy continued to be in stagnation while debt soared. However, international bodies, mainstream analysts, and banks preferred to ignore the risk, instead continuing to announce impossible growth estimates for the following year and science-fiction banks’ profitability improvements.
Italy’s economic problems are self-inflicted, not due to the Euro. Governments of all ideologies have consistently promoted inefficient dinosaur “national champions” and state-owned semi-ministerial corporations at the expense of small and medium enterprises, competitiveness and growth, labor market rigidities created high unemployment, while banks were incentivized to lend to obsolete and indebted state-owned companies in their disastrous empire-building acquisitions, inefficient municipalities, as well as finance bloated local and national government spending. This led to the highest Non-Performing Loan figure in Europe.
Now, the new government wants to solve a problem of high government intervention with more government intervention. The measures outlined would imply an additional deficit of some €130bn by 2020 and shoot the 2020 Deficit/GDP to 8%, according to Fidentiis.
Italy’s large debt and non-performing loans can create a much bigger problem than Greece for the EU. Because this time, the ECB has no tools to manage it. With liquidity at all-time highs and bond yields at all-time lows, there is nothing that can be done from a monetary policy perspective to contain a political crisis.
In Spain, something similar happened.
The Spanish recovery from the worst crisis in decades was impressive and an example for other European countries, but weak and fragile. Spain recovered more than half of the jobs lost during a crisis and slashed deficit by half. Exports rose to 33% of GDP.
However, large imbalances continued to build.
Spain, like Italy, France and Portugal, saw a rising populist wave and, in typical European Union fashion, decided to combat populism by increasing spending and adding public sector imbalances. By doing so, Spain, like Italy, did not stop the populist demands.
However, growth was impressive. In 2018, despite an evident slowdown of the Eurozone, Spain showed a 3% annualized growth in the first quarter. The reason for the difference in performance of Spain relative to other neighboring countries was a very ambitious set of structural reforms. But they came at a cost, as we have seen in many other countries where tough decisions had to be made, and the government lost an absolute majority in...