Italy’s Debt Problem
Italy is an amazing country with a long history, outstanding food, great wines, and unsurpassed culture. But beneath this beauty lies an economic and political crisis that could lead to the next global financial collapse.
Italy’s government owes its creditors more than $2.5 trillion, an amount equal to 133% of its GDP—making it one of the most indebted nations in the world.
Italy is part of the eurozone, whose members agreed to abide by the fiscal rules set by the Maastricht Treaty of 1992. These rules include:
-
A government budget deficit of 3% or less of GDP.
-
A debt-to-GDP ratio of 60% or less.
-
Exchange rate stability.
-
Long-term interest rates are no more than 2% above the lowest-inflation EU member states.
From the start, Italy struggled to meet these standards. But it was certainly not the only eurozone member that did. Greek politicians, for example, used accounting tricks like excluding military spending to qualify. Italy, meanwhile, was admitted under relaxed rules once it became clear that it couldn’t meet the criteria either.
Italy joined the eurozone on January 1, 1999, with hopes that the euro would impose fiscal discipline. But that never happened.
Political Instability and Economic Stagnation
The promise of the euro was that it would force Italy to put its financial house in order. But over two decades later, economic growth has stagnated. Per capita income in Italy is barely above its level from two decades ago, while Germany’s has grown by 28% and France’s by 17%.
Now, Italy is in the process of forming a new government, led by the Democratic Party’s Nicola Zingaretti and the populist Five Star Movement’s Luigi Di Maio. Both parties want to renegotiate the EU’s budget deficit rules. If the EU doesn’t agree, Five Star has even proposed a nationwide referendum on whether Italy should remain in the eurozone.
Meanwhile, Matteo Salvini, leader of the right-wing League party, adds further uncertainty. He triggered the current political crisis when he withdrew the League from its governing coalition with Five Star. Salvini believes Italy needs a “fiscal shock” to spur economic growth. He proposes introducing a parallel currency to the euro, which would allow Italy to print money to pay its bills.
Former Prime Minister Silvio Berlusconi also supports a two-tiered currency system, with the domestic lira used for internal payments and the euro reserved for international transactions. He argues that devaluing a domestic lira would spur Italy’s economic growth.
Italy vs. The European Central Bank
None of Italy’s political leaders are willing to play by the European Central Bank’s (ECB) fiscal rules. And if the ECB tries to enforce them, Italy could pull out of the euro altogether—triggering a global financial crisis.
The crisis could start if the European Commission (EC) refuses to approve Italy’s budget. Italy managed to get its 2019 budget approved by promising to reduce spending and make structural reforms. But those promises went unfulfilled. Now, the EC is threatening legal action and still has to approve Italy’s 2020 budget, which includes proposals for lower taxes, more liberal pension policies, and guaranteed family income.
If this sounds familiar, it should. Italy’s current negotiating tactics resemble Greece’s strategy during its 2015 debt crisis. Greece threatened to reintroduce the drachma unless it was allowed to flout the euro’s fiscal rules. The EU eventually forced Greece into a fiscal austerity plan in exchange for debt relief, with disastrous results. Greece’s economy shrank by 25%, home prices fell by 40%, and hundreds of thousands of Greek citizens emigrated.
The Global Financial Fallout
Italy’s political leaders don’t want a repeat of the Greek tragedy, and they have a lot more leverage. Italy’s economy is ten times the size of Greece’s, making any sanctions by the EC a significant threat. If the EC refuses to approve the 2020 budget, it could push Italy to leave the eurozone or default on its debt. And that would be catastrophic for the entire world.
If Italy reintroduces the lira, its value would plummet against the euro immediately. This would make it even harder to repay its €2.5 trillion debt, most of which is euro-denominated. A default is inevitable. Nearly €400 billion of that debt is held by the ECB. This means other eurozone members—particularly Germany and Greece—would bear the burden of Italy’s failure. Germany, for instance, would have to absorb €120 billion, equivalent to 3.5% of its GDP.
How do you think German and Greek voters would react to bailing out the ECB because Italy refused to follow the rules?
And that €400 billion is only a small portion of Italy’s total debt. French banks hold €285 billion, German banks €58.7 billion, Belgian banks €25.2 billion, and UK banks €17.4 billion. A default would decimate the European banking system.
How Do You Protect Against Bail-Ins?
How do you protect against bank bail-ins? Can you avoid them entirely? Here are the seven ways we’re recommending to our clients right now: How to protect against bank bail-ins.
The Domino Effect: From Italy to the World
The Cyprus banking crisis of 2013 offers a chilling preview of what could happen across Europe if Italy defaults. After lending billions to Greece, Cyprus faced a liquidity crisis and shut down its banks for 12 days. Depositors were unable to access their funds, and once banks reopened, strict withdrawal limits were imposed. Depositors with uninsured accounts over €100,000 lost their money in exchange for stock in the failed banks. This “bail-in” scenario could spread across Europe in the event of an Italian financial collapse.
But the crisis wouldn’t stay in Europe. In 2008, the bankruptcy of Lehman Brothers, with $619 billion in debt, sparked the largest global financial collapse since the Great Depression. Italy’s debt is five times larger than Lehman’s. A default would send shockwaves through the global financial system, wiping out French banks, toppling European banks, and leading to a full-scale financial panic. The ECB would be forced to intervene with massive quantitative easing, but uninsured depositors would likely face Cyprus-style bail-ins and withdrawal restrictions.
The panic wouldn’t stop in Europe. US banks, pension funds, and insurance companies holding European debt would face multi-billion-dollar defaults, and the financial crisis would spread quickly to the US and beyond.
Lessons from Past Crises
The soul-crushing reality is that we could be months or even weeks away from a global financial crisis far worse than what we experienced a decade ago. Looking back on that crisis, there are several lessons we should have learned but didn’t:
-
Politicians lie. A few weeks before Cyprus declared a bank holiday, its leaders promised that deposits would be fully backed and that eurozone taxpayers would finance any bailout. Obviously, that was a lie.
-
The swift win the race. Those who pulled their uninsured deposits from Cyprus banks before the bailout kept 100% of their capital. Those who delayed lost up to 100%.
-
Cash is king. Anyone with euros in physical cash fared far better than those with euros in bank accounts.
How to Protect Yourself
How do you protect yourself from the coming collapse? Don’t believe the reassurances from politicians and the mainstream media. All is not well with Italy’s economy, and the euro is not as stable as it seems. To safeguard your assets:
-
Hold liquid assets in physical currency and diversify into precious metals, gold, and other tangible assets to ensure your wealth isn’t tied up in vulnerable financial institutions.
-
Keep your bank deposits well below the maximums covered by deposit insurance to reduce exposure to potential bail-ins or bank failures.
-
Choose well-capitalized banks with high levels of “Tier 1” liquidity (Tier 1 liquidity refers to a bank’s core capital, which is used as a buffer to absorb financial shocks). Make sure these banks have minimal exposure to European debt.
-
If you have at least $500,000 or more to spare, consider opening an account with an offshore private bank that has minimal exposure to commercial lending and derivatives.
-
Avoid institutions deemed “too big to fail.” Move your assets away from these banks to reduce vulnerability in case of financial crises.
-
Consider international diversification. Spread your investments across multiple regions and financial institutions to mitigate risks associated with bank bail-ins and other local financial disasters.
With the global financial system hanging in the balance, the time to take action is now. Don’t wait for the next crisis to hit—protect your assets before it’s too late.
Need Help?
Since 1984, we’ve helped more than 15,000 customers and clients protect their wealth using proven, low-risk domestic and offshore planning. To see if our planning is right for you, please book a free, no-obligation call with one of our Associates.
