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Our current scenario analysis

Italy

It had been hotly contested. But then, the populist coalition of Cinque Stelle and Lega decided to make good on their proposal to introduce so-called Mini-Bots, i.e. government bonds in miniature denomination to operate as a parallel means of payment beside the euro to pay for government contracts.

The detrimental consequences feared by many economists did not take long to materialise: Within a few months, the availability of euros in Italy’s domestic payments system was suffering badly, because many businesses took to hoard euros by paying their bills in turn with Mini-Bots exclusively. The Italian central bank frantically tried to stem that effect, but to no avail: Only the ECB would have had the means to provide the necessary surplus euro liquidity. Its board, however, decided against doing so for fear of becoming even further embroiled in the heated debate about the Target2 balances, the transfer system between the member central banks of the eurozone.

Anyway, hoarding euros was but for the bigger firms only: Small craftsman as well as family businesses faced by perennial cash flow pressures soon had only Mini-Bots as means of payment available. Hence, they ceased to be able to continue trading with other European countries. At the same time, European businesses retreated from participation in tender procurements by the Italian government, for the latter, too, had merely substantially reduced euro balances at its disposal. Hence, Italian bond yields have climbed to a new high since the sovereign debt crisis of 2012, with Rome now having to pay coupons in excess of 5 per cent to refinance itself on the market for euro funds. That level, of course, would trigger a collapse of the Italian state finances in the long run.

The already fragile Italian banking sector, in turn, already faces a full-blown crisis: Domestic as much as foreign account holders have been transferring euro balances to other European countries while Mini-Bot-accounts had to be created. Soon, many banks were forced to introduce over-the-counter euro-Mini-Bot exchange rates in order to preserve at least a fraction of euro balances in their books. That exchange rate, however, has been deteriorating by the month.

Now, there are first calls in the government coalition to hold the originally insinuated referendum on Italy’s membership in the eurozone; and the mood among the Italian people with regard to the current crisis bodes ill.

See the related issue of our former monthly bulletin for a detailed analysis of the Italian election, too!

Decision tree euro crisis