As we wait to see the significance of today’s big turn in equity markets it is worth thinking about Italy and the possible effects if it should abandon the Euro. Since the collapse of negotiations between the antagonistic pair of parties that were the main winners of the last election, this departure may seem remote but there us a groundswell of public opinion in the country that blames Euro membership (not the EU, just the currency) for the country’s troubles, so it will remain ‘an issue’ for the foreseeable future.
We have written for twenty-two years that a single currency would have a divisive effect on the fortunes of different European regions and this has proved exactly correct and is now widely seen as true, having been shouted down for over a decade. Those regions that found themselves in a good position to compete economically when the currency was launched have gone from strength to strength, unimpeded by rising exchange rates (or interest rates, for that matter). This turned out to be mostly Germany of course but that was largely a matter of chance as they had only recently enacted some rule changes to fix their poor competitive condition. What timing!
Meanwhile, those countries or regions that couldn’t compete have marked time or gone backwards, un-compensated by a falling exchange rate. This has been mostly the Mediterranean countries (and Portugal) but also includes the eastern part of Germany whose unlucky people were stuck with an exchange rate that is the same as that of the prosperous western part of the country as a consolation prize from the economically illiterate man in charge at the time (Kohl, Merkel’s patron) of unification. The Easterners’ pain has been real since then but at least they can move to Munich to find work.
So the weak countries in the EU find that the exchange rate of the Euro against the world’s other currencies is too high and has ‘hollowed out’ their economies. Germany and a few of its Northern neighbours are endlessly stimulated by the same exchange rate, as for them it is too low – Germany is usually the world’s biggest exporter, which probably wouldn’t be so without this odd situation. The exchange rate is pulled upwards by Germany’s success and downward by the club Med countries’ failures and ends up suiting no-one. What if Italy leaves?
Clearly, a major drag on the Euro would be removed at a stroke and it would shoot up like a beach ball released under water. Italy would adopt a currency that would soon be a lot cheaper than their current one and this would stimulate economic activity there, even though it would leave them with a national debt that suddenly got much bigger, as it is denominated in Euros and is already pretty much un-repayable. Some political fudge would be needed, as usual.
We are more concerned with the immediate prospects for the currency however, so if there is any chance that events will unfold in such a way that Italy leaving the Euro becomes a real possibility, buy the Euro for a serious up move.
