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거시경제 및 지정학

Italy, Europe ... & the United Federation of Planets

2019년6월3일 - 4 분 읽기

It’s easy to ridicule the lumbering political institutions of the European Union, but unwise to bet against them.

A recent meme shows an orbiting U.S.S. Enterprise beneath the headline: “The year is 2387.  Earth is a member of the Federation of Planets – but without Great Britain which is still trying to leave the EU.” Beyond underscoring the sad unraveling of British politics, the image captures Europe’s grand ambition toward a future of sovereign states integrating enough economically and politically to share a set of common rules.  It may well take another few centuries, but the end-game may just be a planet that is coherent enough to join Star Trek’s  inter-galactic political union.

As Earthlings, therefore, we should all be rooting for Europe to succeed amid the current headlines around Brexit, the rise of extremism and the stand-off over the Italian budget.  As investors, of course, time horizons are considerably shorter and markets are much more volatile, but keep your eye on bureaucratic inertia, financial interdependence and historic aspirations.  It’s easy to ridicule the lumbering political institutions of the European Union, but unwise to bet against them.

Political Aspirations:  The rise of populists and extremists—mostly on the right—is undeniable, amid deep discontent about inequality across Europe.  However, the anger is directed as much at elites in their own national capitals as it is at greater European institutions.  Yet the calls to dismantle these institutions even among the extremes have evolved into determination to improve how it works.

Polls consistently show most Europeans view the EU as inefficient and intrusive, but nevertheless as a crucial bulwark for continental peace and prosperity.  A Pew Survey found 67% of those polled across 10 member states have a favorable view.  The history of continental wars looms larger than most outsiders understand, while Europeans sense the importance of acting together to have their voices heard in a world increasingly dominated by the United States and China. 

The results of the latest elections are something of a Rorschach test in which pessimists will point to collapse of traditional centrist parties and the rise of the extremes.  Yet there were also significant gains for so-called “liberals” and Greens, strands that have moved mainstream with visions of a Europe they want to build rather than dismantle.

This means the new EU parliament will be dominated by four pro-European parties rather than two, which will be more complicated, but perhaps also genuinely more representative given higher voter turnout.

Institutional Strength:  Ironically, Britain’s departure has reinforced the EU.  Far from triggering a queue for the door, the rest of the continent has negotiated with remarkable coherence, steadiness and focus.  Leading Conservative candidates talk about leaving without a deal, but the EU itself has little interest in a messy exit and will likely grant further extensions when the deadline looms.

Meanwhile, even with the solid showing of Nigel Farage and his Brexit Party in the EU parliamentary elections, most British votes were cast for parties that prefer to remain in the European Union.  More important, the EU accounts for 44% of British exports and 53% of its imports, meaning the European institutions and rules will continue to loom large in most economic decisions confronting parliament even after it legally departs.  (Sadly, Britain just won’t have much say in the rules themselves.)

Financial Interdependence:  For financial markets, this fuzzy talk of aspirations and institutions doesn’t mean much amid bond volatility around the Italian budget standoff.  Flush with electoral success, populist leader Matteo Salvini is emboldened to press for more spending to support lagging Italian growth.  The European Commission has responded with threats to impose fines for missing budget targets, which few believe they will ever enforce.  Italian bond spreads have widened, even compared to countries only recently considered basket cases.


Source: Factset, as of Dec 31, 2018.


Source: Bloomberg, as of May 31, 2019.

Investors will wring their hands over the absurdity of a political and economic union that pretends to enforce fiscal discipline, but can’t. There will also be talk about a potential cataclysm triggered by a default in the world’s eighth largest economy.  But that won’t happen either.

For all the worries about Italian gross debt levels, they have been stabilizing and they are much less worrying on a net basis when substantial government assets are brought into the picture.  Also, Italy’s budget is hardly the disaster the headlines suggest. Most of its debts were run up long before it joined the euro and it has been running a surplus before interest payments for many years.  

In fact, Salvini is not wrong that Italy could use a little more fiscal space.  In a world of low growth and low interest rates, the entire EU could use a little more stimulus and fiscal support.

The real strength of the European Union and the euro area itself comes from the financial interdependence of its members.  Departure or expulsion are about as close to impossible as you get in the political world. 

Consider the recent experience of Greece.  If there were ever a country that deserved to be evicted from the common currency it was Greece in 2015, having just voted to renounce the terms of its bailout agreement in a surprise referendum. If there were ever a country that might have rightfully chosen to pick up and leave the euro area, it was that same Greece, following years of crushing austerity at the hands of its inflexible European lenders.

And yet, when push came to shove, Greeks saw that exit meant a complete collapse of its banking system and long years to rebuild even a rudimentary financial system in new drachmas.  Such an abyss on the scale of Italy will always force more sober thinking on all sides long before we get to a moment of default or exit.  The moment either scenario becomes remotely plausible, there will be a run on Italian banks that will cool political tempers.  There will also be enormous pressure on all other euro economies as the calamity of a potential Italian exit would take them down too.

So, buckle up for turbulence, but don’t bet on a crash.  The political aspirations, institutional strength and financial interdependence suggests a European project that is durable and resilient.  The evolution will be slow and the bond markets will bounce, but the EU – and even the United Kingdom – will be with us when the Klingon threat emerges. 

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