Why Italy’s Face-Off With The EU Matters

October 2, 5:00 pm EST

Italy’s face-off with the EU is ramping up, following their announcement last week of plans to increase their deficit spending.

Why does it matter?

This is another round of populist push-back against policies that have stifled economic recovery and threatened sovereignty over the past decade.  We’ve seen it play out in Greece, in the UK, and in the U.S. 2016 election.

With risk rising of a shakeout in Europe, you can see in the chart above, money is moving out of Italian government bonds and into German government bonds.  This sends Italian yields UP and German yields DOWN — on what is already a 300 basis points spread between the two 10 year borrowing rates.  A continuation of this puts pressure on Italian solvency.

But this will all likely end favorably for Italy and for the broader European economy.  Because as Italy pushes back on austerity, we’ll likely to see the EU make concessions on fiscal constraints, that will open the door for fiscal stimulus across Europe.

The policymakers know very well that the health of the “monetary union” is the lynchpin in Europe.  If it’s pulled (by an exit of a constituent member), the European Union will crash and fracture.  That’s why the ECB stepped in back in 2012 to prevent debt defaults in Italy and Spain.  And that’s why EU officials have made concessions throughout, on aid to keep Greece alive.

Italy’s resistance will come with a lot of draconian threats and warnings (from EU officials, as we’ve already seen), but in the end Italy may be the catalyst to unlock growth in Europe.

Trump has laid out the playbook for economic stagnation.  It’s aggressive fiscal stimulus.  Europe should follow that lead.

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