The EU Could Become the Real Problem

The anti-establishment populist movement is expanding in the EU, and is now centered on Italy. Hungary, Poland, Austria and voters in Germany and Spain are pushing an anti-Brussels agenda, which is also anti-Germany. Italy is in terrible financial shape with a deficit that is now past impossible to rectify. The new government is pushing for a new budget that exceeds the limits set by the EU in Brussels. The new coalition is challenging the EU with a spending plan which is likely going to cause Italian bonds to demand a materially higher yield, and which may be unsalable to anyone other than the ECB. The European banks, and especially the German banks are already full up with Italian sovereign debt, and cannot risk taking any more. Draghi has told Italy that the ECB is not going to bail out Italy if they exceed the budget guidelines, and that would leave a bond yield through the roof, which would create large losses to the European banks holding Italian paper. While the ECB and Germany can cover the crisis in the short term, the ripple effects on the Euro and on bank credit in the EU could potentially be very bad. It is a classic damned if you do, damned if you don’t for the ECB. There is even talk of Italexit if things really go off the track.

Merkel is in serious political trouble and it is unclear how much longer she can remain in office. Possibly not much longer.  Even if she does manage to stay, she is having to create a new coalition, and she will be in a weak position. She has run the EU for the past decade or more, and if she leaves, the political chaos will be serious. There is no other leader right now who can have the power she had.  Complicating things is Brexit, which will come to a head in the next few weeks. If that gets resolved peaceably, it will help calm things a lot, but if it turns into a hard Brexit, things in the EU could get ugly quickly. You might then see a Italexit, or Hungary. We simply do not know what might happen. If we have a hard Brexit, combined with an Italian fight over budgets, and then Hungary and Poland and Austria piling on, things in the EU could turn very chaotic quickly. That is one reason the EU is anxious to resolve the trade issues with Trump, to get that risk off the table. It is also why you should stay away from Europe until thing get more clarity, which may be many months away.