Italy’s Nightmare Has No End In Sight

(Bloomberg Opinion) -- Italy’s president Sergio Mattarella faced an impossible choice when vetoing Paolo Savona, a leading euroskeptic economist, as Italy’s finance minister.

Savona’s selection risked causing a self-fulfilling crisis, which would have pushed Italy out of the euro by stealth. Yet even the presidential veto, and subsequent decision to appoint a technocratic government, haven’t been enough to reassure investors. Only a promise from all parties that they will never leave the currency union would reverse the sharp selloff in Italian bonds. That’s unlikely to happen.

Mattarella was well within his rights to block Savona’s appointment, despite claims that this was an attack on democracy. Italy’s constitution says the president has the final say over the choice of ministers. Past presidents have exercised this power, for example during the formation of Silvio Berlusconi’s first government in 1994. In the past, parties have usually accepted the rejection. Here, the anti-establishment coalition of Five Star and the League refused to change tack, triggering a collapse of their incipient government.

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Matteo Salvini, leader of the League, claimed Mattarella blocked Savona because he was disliked in Paris and Berlin. The 81-year old economist had compared the euro to a “German cage” and hinted it was a continuation by other means of the Nazi plan to dominate Europe. However, the real reason for Mattarella's move was more nuanced: He was deeply troubled by Savona’s conviction that Italy should have a secret “Plan B” to quit the euro in the event of a crisis.

The problem with these types of contingency plans — even if you’re still paying lip service to the Plan A of trying to rework the euro-zone relationship — is that markets tend to take them seriously and run for the hills. If investors think Italy’s finance minister may have a hidden roadmap to quit the currency union, they’re going to sell their Italian assets immediately, fearing that they might be re-denominated in cheaper lira (and, in the case of bonds, be defaulted on).

Mattarella has never said Italy cannot be allowed to leave the euro. All he has argued for, correctly, is that this should be done “openly.” Five Star and the center-right alliance — which included the League — did not campaign on an anti-euro platform, nor was a departure included in their coalition agreement. Savona’s appointment risked creating a sovereign debt crisis and pushing Italy out of the euro without a popular mandate for an exit.

Now, though, the genie of “Ital-exit” is out of the bottle and it will be very hard to put it back in. Investors are shunning Italian assets, with the yield on Italy’s two-year bonds hitting 2.83 percent, the highest since 2012, on Tuesday before paring losses.

A new election could see either Five Star or the League (or, indeed, an alliance of the two) storming to victory. Yet it’s still unlikely that either will campaign explicitly for Italy to leave the common currency, as they know most voters are against it.

The most effective way to reassure markets would be a credible pledge from all parties that Italy will never, under any circumstance, leave the currency union. Of course, that’s very unlikely to happen given the League’s attachment to their Plan B.

So, in the absence of a commitment to the euro zone, the best chance of clarity would be if the next election became a showdown over the single currency. If the euroskeptics won the day, they would have the popular mandate to hire the finance minister of their choice. But, again, this is unlikely to happen given that the populists have thrived through holding an ambiguous position. In the meantime, investors will continue to take flight and Mattarella will still have an impossible job.

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