Imagine a new year’s resolution list that reads as follows: first, give up chocolate; second, get divorced. You would rightly say this is absurd. If you are serious about divorce, you would not put it on a list. If you were pedantic enough to do this, divorce would not be item number two.
But that is precisely how the populists in France and in Italy have cast their policies on the euro. They seem to favour euro exit, but want to delay the decision for a while, and then put the whole thing to a referendum. This is telling us that Marine Le Pen and Beppe Grillo, the leaders of the National Front in France and the Five Star Movement in Italy respectively, are wholly unprepared for government. They are not so much extremists as charlatans.
It is possible, though not easy, to make an intellectual case for euro exit in either country, but neither Grillo nor Le Pen have made it. If you were serious about euro exit, you would have realised that this is a very big deal – the one issue that will define your period in power. You will deal with almost nothing else for a number of years. It is much bigger than Brexit – and that occupies the UK government full-time.
If either country left the single currency, it would lead to the biggest default in human history. There would be bank crises throughout the EU. The bloc may struggle to stay together. The euro itself may be threatened. A euro exit is about as complicated and risk-prone as starting a war. You will need to secure your borders to stop people from taking the euro cash outside the country. You will need to engage the police to crack down on riots. You will need a military-style operation simply to carry out the logistics. Have you thought this through? There are virtually no avenues towards an orderly euro exit, not even a legal one. Think of euro exit as a military putsch – something you do over a weekend with tanks on the streets.
Monetary regime
I am baffled when I hear Luigi di Maio, the Italian politician most likely to become prime minister in the event of a Five Star victory, say that he is committed to a euro referendum as a second-order priority for his party. But first, he wants to fight poverty. In other words, he is giving up chocolate first before divorcing his wife. Di Maio is either not telling the truth, or, more likely, he is unprepared for office. He is only 30. He was six when, in 1992, Italy was forced out of the European exchange-rate mechanism, along with the UK. Anyone who went through that period would know that monetary regime changes are traumatising. And Italy’s ERM exit pales in comparison to a euro exit.
Think about a foreign investor. If you expect Italy to denominate its debt into a new currency – call it lira – that new currency would devalue. What would happen to Italian sovereign bond yields, say a 10-year bond that pays a coupon of 2 per cent? If an investor expects a 40 per cent devaluation, the yield would rise to 6 per cent right away.
Insolvent banks
Investors would not wait until a referendum. Once it became clear di Maio was the next prime minister, a rational investor would assume an exit vote was probable, estimate the size of the devaluation, and calculate how much the yield would have to rise right now to neutralise a future redenomination. On election night, di Maio would have to deal with a run on the Italian financial system. The banks would be insolvent the next morning. Mario Draghi, European Central Bank president, would not give a whatever-it-takes guarantee to a politician threatening a referendum. Di Maio would have at most 24 hours to get out, or call off the vote. And he is not prepared for the former.
Greece briefly toyed with the idea of a parallel currency during the Athens spring of 2015 – but Alexis Tsipras, prime minister, considered the idea too risky. I see no signs that Le Pen, Grillo or di Maio are any more serious than Tsipras.
The one forecast I will make is this: if Italy, France or anybody else were to leave the euro, it would not happen through a referendum, but an accident. The bad news is that accidents do happen. – Copyright The Financial Times Limited 2017
