Italy Says ‘No’ — Wants More of the Same

We start this week in Italy. As I write, the nation is voting in a referendum that could shake up Italy’s system of government in a big way. The referendum is an attempt by Prime Minister Matteo Renzi to end Italy’s stifling political bureaucracy and facilitate economic growth.

But, according to early exit polls, the referendum will suffer a resounding ‘NO’ vote. Given that this was always the likelihood, it hasn’t had a great deal of impact on markets outside of Italy. The Italian banking system is in trouble, and a few of its big lenders need to raise substantial capital to survive.

A ‘NO’ vote will make this more difficult, but, so far, markets haven’t been concerned about any threat of financial contagion. Whether this view changes should Renzi resign is another matter.

With around 60 different governments since the Second World War, it looks like being business as usual for Italy. Which is not good.

But with the European Central Bank continuing to spray €80 billion a month into the financial system via its quantitative easing program, it’s not too surprising that markets are sanguine.

And Italy’s government, despite being one of the most indebted in the world, can still borrow for 10 years at 1.9%. Not bad.

Italy’s private sector is in much better financial health. In the first nine months of the year, Italy generated a current account surplus of €29.89 billion. In other words, Italy’s non-government sector is a net creditor. It saves and lends, while the government borrows and spends.

Part of the reason for this is that Italian industry makes a lot of stuff that the rest of the world wants. My Bezzera coffee machine is a good example. I bought it a few years ago and it churns out quality coffee every time — better than I get at most cafés.

Decent cafés in Melbourne now charge $4-plus for a coffee, which is crazy. If you’re a coffee drinker who is more interested in the coffee than the café scene, I recommend investing in a good Italian espresso machine. You’ll recoup the upfront cost within a year or two.

But the favourable export performance of Italian industry is flattered by the underperformance of domestic consumption. Because the economy is in a perpetual low growth environment, not enough jobs are being created. Apparently, youth unemployment is around 36% (according to an article in the Financial Times).

If jobs are scarce, there’s not going to be a lot of borrowing going on. And when the banking system is sick, this restricts the credit creation process even further.

It’s quite clear that Italy needs major reform. But the reform agenda of Renzi has been hijacked. The vote has come down to a vote between the ‘elites’ (headed by Renzi) and everyone else, despite it being anything but.

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With a resounding ‘NO’ vote, you have to wonder just what needs to happen for Italy to take action. No wonder the ambitious youth are leaving.

Contrast this situation with Australia. We have a strong economy (relative to many other parts of the world), and this has created employment and credit creation (debt growth).

Most credit creation in Australia goes into rising house prices, which creates a wealth effect and ‘services-based’ economy as people spend that wealth.

So we use the benefits of private debt growth to buy coffee machines from Italy to fill our cafés and develop a thriving café culture. We do it on borrowed money, borrowed from nations like Italy who actually make stuff and save the proceeds.

While saving more than you spend sounds virtuous, in the case of Italy, the spending part of the equation is constrained by structural flaws in the economy.

Because of this, Italy’s savings flow to the UK, the US or Australia — the world’s major borrowers and importers of foreign capital. Ironically, there are better returns on offer by investing in debt-dependent economies. That’s because they have a flexible structure that makes investing relatively easy.

They also offer other rewards. For example, the Financial Times, in covering the Italian referendum, profiled Davide Serra, the Italian founder and chief executive of London-based boutique investment fund Algebris.

He is a friend and adviser to Matteo Renzi, and a critic of Italy’s entrenched elder statesmen who are slowly running the country into the ground. He wants Italy to change, but, even if it voted ‘YES’, he would not go back:

Is there any scenario in which Mr Serra would move back to Italy? “No, the best way to do what I do is to be in London,” he says. “It is freedom.”

Chalk it up as another of life’s ironies. That is, highly indebted liberal democracies, like the UK, US and Australia, offer their citizens debt…and freedom!

It will be interesting to see what happens in the years to come if the big creditor nations across Europe ever get their house in order enough to promote growth and encourage credit creation.

That is, they might start consuming more and saving less. That means fewer savings to finance the debt appetites of countries like Australia. Remember, not every nation can consume more than it produces.

Excess consumers like us need excess producers like Europe (and Asia) to finance our standard of living. It’s been like this for decades, and doesn’t look like changing anytime soon. But it’s worth keeping the ramifications in mind.

Fortunately for Australia, the entrenched beneficiaries of the status quo in many creditor nations means we will receive ample capital flows to feed our debt appetite.

It’s just how the ‘deep state’ works. A state which, by the way, is alive and well in Australia too. I won’t go into it here, but keep an eye out tomorrow for an explosive new book by Markets and Money Editor Vern Gowdie tomorrow which delves into this topic.


Greg Canavan,
For Markets and Money


Greg Canavan
Greg Canavan is a contributing Editor of Markets and Money and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails. For more on Greg go here.

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