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Out of the Box: The Roman Chariot Race-The Facts, The Fiction

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Bloomberg states:
“The European Commission could decide as soon as June 26 to trigger a disciplinary procedure against Italy, in order to force the government in Rome to clean up its public finances.

Here are the next steps:
The commission has to propose opening a so-called Excessive Deficit Procedure
– That could happen when the commissioners meet Wednesday or on July 2

Their decision needs to be endorsed by EU finance ministry officials
– That could happen at their regular monthly meeting on July 1-2

EU finance ministers meeting on July 8-9 will have to give their approval too
– They decide on whether to open the procedure, and how stiff the fiscal adjustment should be

Once the procedure starts, the commission has 20 days to decide whether to recommend an immediate financial penalty
– That could mean depositing as much as 0.2% of Italian GDP with EU authorities

EU members have to wave that through too
– They have 10 days to decide, and it requires a majority of states to block the move

If the commission and member states ultimately decide that Italy hasn’t complied with their demands, Rome would forfeit its deposit and face additional sanctions worth as much as 0.5% of its GDP.”

There are several major issues here. One is size. Italy has the eighth largest economy in the world and they are playing a major game of “Chicken” with the European Union. The EU has already undergone a shock from Greece, and they are facing “Brexit,” and now Italy is pushing the borderlines. Italy says that they want to remain in the EU, and says they want to change it from the inside, but what they say, and may actually mean, are quite different in my view. “Itwent” could be forthcoming.

A major part of the problem is Italy’s mounting debt levels, as the ruling coalition wants to add even more debt to their budget. In 2018 the country’s ratio of debt-to-GDP ratio was 132.2% and is expected to rise to 135% by 2020 based on forecasts from multinational agencies such as the International Monetary Fund. “The last time Italy’s debt ratio was as high as it is today was in the 1940’s when the government was in default on its external debt,” states a recent report from London-based financial research firm Capital Economics.

Capital Economics also stated, in their recent report, “In order to stop its debt ratio from rising over the next five years, Italy’s economy would have to grow 0.7 percentage points per year more quickly than expected – i.e. it would need to expand by 1.3% per year. For a country that has achieved average growth of just 0.4% since 1999, and grew by just 1.5% per year from 1999 to 2007 when the global economy was expanding rapidly, this seems like a tall order.”

Deputy Prime Minister, Matteo Salvini, on Friday, ruled out the possibility that the government could pass an additional corrective budget to avert the threat of Italy facing an EU infringement procedure. “We won’t allow anyone in Brussels to stop the country’s growth,” League leader Salvini said at a finance police event. “There will be no corrective budget.” With that statement, alone, he is throwing the Chianti right in the faces of the European Commission.

“It does seem a matter of “when,” rather than “if,” another full-blown sovereign debt panic will happen. The bottom line is that if a serious new crisis blows up, the Italian government is positioning itself to demonstrate to its voters that it has not sought to leave the Eurozone, but rather that the Eurozone is leaving Italy,” states London-based financial firm TS Lombard.

Italian Senator, Alberto Bagnai, has even branded the bloc’s behavior as tantamount to “blackmail” as he urged Italian Economy Minister Giovanni Tria to resist pressure from Brussels. He also stated that, “In the event of an exit from the Euro or substantial macroeconomic shocks, like the Lehman Brothers crash, the next day people would still go to work or to the cafe. It doesn’t mean the world stops because the system has changed.”

What has actually happened, in my opinion, and as predicted, is that the German/French alliance, which has governed the EU since inception, is breaking apart as a large minority of nationalists, populists, were recently voted into power in the recent EU elections. Also, the German choice for the new head of the ECB, Jens Weidmann, is not only opposed by the nationalists, but also by France, which is causing huge internal strife in the European Commission now.

French President Macron, said on Friday, “So I’m very happy, really very happy, that members who strongly opposed Mario Draghi’s decision and even took legal action against the OMT [Outright Monetary Transactions] mechanism that was put in place are converting, albeit belatedly converting. I think it shows that there’s good in all of us and it reinforces my optimism in human nature.” He was referring to an interview this week in which Weidmann, who testified against the ECB’s bond-buying plan in Germany’s Constitutional Court, told the weekly Die Zeit that the Court of Justice of the EU had determined that the policy was legal and “moreover, OMT is current policy.”

Weidmann’s grudging acceptance of OMT was widely seen as a last-minute effort by the conservative Bundesbank chief, a former economic adviser to Chancellor Angela Merkel, to make himself acceptable to other EU leaders as a candidate for Draghi’s succession.
Further, I expect the ECB to be back in the markets soon, with a whole other round of Quantitative Easing. More money for the European banks, more buying of sovereign debt and corporate bonds, and more negatively yielding debt, already having broached the $13 trillion level. I think the EU is in quite serious trouble financially, as the nations in Europe can only afford their budgets, and their social programs, because of the ECB’s “Whatever It Takes,” forthcoming measures. Yet “Brexit” and “Itwent” are on the horizon and the “Risk Factor” is quite large on the Continent these days, in my estimation.

I would not be investing any money in Europe presently unless you have some sort of mandate to do so. Just too much danger there now and the “Risk/Reward Ratio” is just too far tilted towards “Peril.”

Mark J. Grant
Chief Global Strategist, Fixed Income
Managing Director
B. Riley FBR Inc.
U.S. 954-468-2366

Information herein is for general use; is not unbiased/impartial; is current at publication date, subject to change; may be from third parties; and may not be accurate or complete. Opinions are the Author’s, not B. Riley FBR, Inc., or their respective affiliates or subsidiaries. This is not a research report or solicitation or recommendation to buy/sell the subject securities. Investment factors are not fully addressed herein. B. Riley FBR Inc. and their affiliates may have a proprietary position in the subject securities.
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