Berlusconi is Back, and So Is the Eurozone Debt Crisis

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Since the beginning of the year, the markets have been behaving as if the Eurozone debt crisis has been magically solved.

Yields on Spanish and Italian debt are trading more than 1% lower than at their peak, while world stock markets have soared close to all-time highs.

Unfortunately, you can expect that all of this euphoria will fade when the Italian elections take place on February 23-24.

Why?…It's summed up in two words: Silvio Berlusconi.

That's because until recently a win by the former Prime Minister wasn't seen as very likely. Not long ago, The EU establishment believed they had the Italian elections completely wired.

The socialist "Democratic party" led by Pier Luigi Bersani was expected to win and be supported by a coalition of center parties led by the EU's favorite, Mario Monti, imposed as prime minister in November 2011.

Both of these candidates were safely pro-euro, and prepared to put Italy through a fair amount of "austerity" to keep it, provided the handouts kept flowing from Germany and the European Central Bank. The status quo wouldn't be threatened.

Meanwhile, the two anti-euro candidates were supposed to be comedians.  

One is an actual comedian named Beppe Grillo, leading an eccentric "Five Star Movement," while the other  is the aforementioned Silvio Berlusconi, who is currently under indictment for sex with under-age prostitutes and therefore (in the eyes of the EU bureaucracy) not seen as a serious threat.

At best it was thought Berlusconi and Grillo might get as much as 30% of the vote between them, but it wouldn't give them any significant power. 

Well, let's just say things have changed.

A Defeat for the Eurozone?

According to the latest polls, Berlusconi's party would get 30% of the vote on its own, while Grillo's would earn a solid 15%.  Not bad for a couple of comedians.

As for the establishment picks, Bersani's party still leads with about 34%, while Monti's supporters trail with around 12%.

That suggests a very close vote, or possibly (if as sometimes happens, voters are falsely claiming to opinion pollsters that they support the "respectable" parties) even a Berlusconi victory, provided he could come to a satisfactory arrangement with Grillo.

But here's where it gets slippery for the EU: Anything but a solid Bersani/Monti majority is bad news for the euro, or at least for Italy's participation in it.

Here's why…

Italy's budget is in fact quite close to balanced (Berlusconi had repaired much of the damage done by his leftist predecessors) which means an Italian exit from the euro — getting cut off from EU handouts and austerity programs — would be pretty painless.

However, if Italy left the euro, it's likely that Spain, Greece, Portugal and very likely France would also be forced out.

But a Berlusconi return to power is not the threat faced by the euro these days.

More Eurozone Troubles

In Spain, Prime Minister Mariano Rajoy has been embroiled in a corruption scandal and the opposition is demanding his resignation.

Rajoy's government is making good progress on Spain's deficit, and avoiding excessive dependence on the EU, but if it's brought down, Spain's gremlins are free to roam wild. In any case, even with Rajoy in power, Spain's youth unemployment rate is an astounding 55%, so safe emergence from the crisis is by no means certain.

Greece, meanwhile, is entering its sixth year of recession, with unemployment above 25% and GDP down 20% from its 2008 peak. Politically, the leftist Alexis Tsipras is running ahead in opinion polls; apart from nationalizing anything available, he would also leave the euro.

And then there's France, home of the 75% tax rate.

France's prospects have actually improved in the last month, with its troops sent to Mali. While economically this expedition will inevitably be a drain, psychologically the sight of French troops entering Timbuktu within a few weeks of their arrival has been an immense fillip to Francois Hollande's government.

However the folly of his policies hasn't gone away. Economically French prospects still look dire, although the markets are still not reflecting this with yields on French 10-year government bonds at 2.28%, up only 25-30 basis points from last year.

For investors that means the message is clear: you should expect further storms from across the pond.

Mind you, a combination of chaos in Europe combined with a successful implementation of the March 1 "sequester" cutting U.S. public spending by $1 trillion could provide U.S. investors with a "sweet spot," in which the U.S. became regarded as the best prospect on the planet and U.S. stocks soared accordingly as they did in the 1990s. 

So overall, investors should stay invested in U.S. and Asian stocks, avoid Europe, and make sure their trailing stops are in place in case a sudden storm blows up.

We'll know more in just a few weeks.

>>For Martin's take on America's fate in all this, see Can the U.S. Economy "De-couple" from the Euro Debt Crisis?

>>Don't miss Why a Greek Exit Would Be the Best Thing That Could Happen.

>>Read Martin's 2013 Eurozone Forecast: Why A Eurozone Breakup Is Now More Likely Than Ever.

Join the conversation. Click here to jump to comments…

  1. domenico maiello | February 11, 2013

    As a 80 years old Italian I cannot share the superficial amateurish analisis of the national situation.

    Surely Berlusconi has many of its past "records" to be blamed but even more surely, it must be underlined that the worst of the Italian problems have been created by the "predecessors" of
    Mr. Bersani politics and also by hymself!

    Unfortunately the real problem of Italy is that, this Country for the stupidity of its politicians
    has been serving more foreign politics and interests than National interests. What was left
    "avaialble" (or unommitted by the above) has been eagerly divored by the appetites of
    cruck politicians who consider their role only for abusing of power!

    Next vote will be an absolute mess with a dozen of conflitting Parties unable and incapable of reaching reasonable compromises on any legal issue and perhaps only able (as in recent past!) to frame what is left to be robbed from our pockets!

    • Sergio Todesco | February 11, 2013

      Agree !00 %,

      Italian politician same mister Monti, serve the foreign interest not the Italian country ! Bur the good lucky must to finish !

      Viva l' Italia !

  2. Shyam Sundaresan | February 12, 2013

    Right.

    The same article acknowledges two things:
    1) ….."Italy's budget is in fact quite close to balanced (Berlusconi had repaired much of the damage done by his leftist predecessors) which means an Italian exit from the euro …"
    2)…"But a Berlusconi return to power is not the threat faced by the euro these days.
    In Spain, Prime Minister Mariano Rajoy has been embroiled in a corruption scandal and the opposition is demanding his resignation…."

  3. margaret fish | March 3, 2013

    So, the Italians want to keep the spending party going and intend to rely on the more productive European nations to bail them out. Good luck with that. Germany and the other more productive countries will not attend the party.

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