The Tremonti Plunge
In recent weeks we have frequently cast our wary eye in Italy's general direction, as we sensed that the crisis may be about to migrate there (see, 'Et Tu, Italy?', 'Out Of Control' and 'Mamma Mia' for details). In 'Et Tu, Italy?' which we posted in late May, we wrote that 'at present, no-one seems especially worried yet' [about the prospect of a credit rating downgrade for Italy], an assessment that was confirmed by the complacency exhibited by many mainstream analysts, of which we cited a pertinent example. Such complacency in the face of a clearly discernible deterioration in the market data is always a red flag to us (people should probably exercise caution in their dealings with Italian banks). Even when our most recent post referencing Italy's growing problems was published - occasioned by the solid technical breakout in 10 year government bond yields and the continued decline in the share prices of major Italian banks - the world at large had not yet focused its attention on the situation. That changed a mere few hours later.
The specific development that the popular media thought most worthy of attention was the political fate of Italy's 'economy minister' Giulio Tremonti.
We would like to point out on this occasion that if an 'economy minister' truly wanted to serve the interests of the economy, he should as the first order of the day following his appointment tender his resignation and demand the disbandment of his entire ministry and its attendant bureaucracy. Alas, Tremonti is actually the 'minister of economy and finance', so he would actually be better described as the finance minister.
It can not be denied that Giulio Tremonti has stood out by insisting on the enactment of politically unpopular measures aimed at extracting Italy from its debt trap. It would normally be laughable to assert that the financial fate of an entire nation hinges on the person of a single cabinet member. However, it is certainly a measure of how tenuous economic confidence has become if observers do in fact maintain this to be the case.
As Bloomberg reported on Friday:
“Speculation is growing that Italy's Economy Minister Giulio Tremonti – credited with shielding the country from the euro zone debt crisis – will soon be forced out of government, which would further raise the heat on Italian bonds.
The yield differential on Italian 10-year bonds versus safer German bunds hit its widest since the launch of the euro on Friday, as the markets worried about contagion from the Greek debt crisis.
Tremonti overcame cabinet resistance to push through a tough austerity programme last week, but now looks increasingly isolated and appears to no longer have the full support of Prime Minister Silvio Berlusconi.
"He thinks he's a genius and everyone else is stupid," Berlusconi said in an interview with Repubblica daily on Friday.
"He is the only minister who is not a team player," Berlusconi said, adding that he would make sure the austerity package was changed during its passage through parliament to make it more attractive to voters rather than markets.
It seems questionable whether the package is even that attractive to markets, however. It was not formally presented until a week after it was approved by the cabinet, and it has been marred by confusion over the measures it contains and how much they are worth.
The premium investors demand to hold Italian 10-year bonds instead of safer German bunds jumped to 2.24 percent from 1.99 percent on Friday. The Italian yield of 5.3 percent is the highest since 2002.
Yet analysts have no doubt the picture would be even worse without Tremonti, who has many critics but whose insistence on keeping a lid on the fiscal deficit is widely seen as having so far shielded Italy from the worst of the euro zone debt crisis.
"There's already growing market focus on whether Italy can bring down its debt and if you add uncertainty about Tremonti being pushed out you get a very dangerous mix," said Raj Badiani of IHS Global Insight.
"It would be a really negative step that would make ratings agencies and markets very nervous."
Badiani said Tremonti's exit might change the "pecking order" of possible contagion from the euro zone debt crisis and soon see Italy looking as vulnerable as Spain.
(emphasis added)
To summarize the above: Tremonti was seen by market participants as a major cog in the up until recently quite popular 'containment theory', which has been variously embraced by analysts and trumpeted by EU commissars as a measure of the 'success' of the bailout strategies embarked on by the eurocracy. This theory held that due to an increasingly visible lessening of correlations in peripheral euro area bond markets and the associated credit default swaps, the eurocracy had succeeded in 'containing' the debt crisis to what today is known as 'GIP' – the trio of Greece, Ireland and Portugal, small nations the insolvency of which was deemed to be manageable.
We always believed this idea to be lacking in foresight and ignoring a fundamental fact of today's intricate web of financial and economic interconnectedness. It sounded analogous to the assertions of Hank Paulson and Ben Bernanke in late 2007 and early 2008 that the 'sub-prime crisis was contained'. What these pronouncements ignored was that one can not 'compartmentalize' the credit markets in this manner when a crisis strikes. The losses suffered in one area of the credit markets will perforce affect other areas of the credit markets, as market players begin to scramble to raise suddenly scarce liquidity. Since we live in an age of universally practiced fractional reserves banking with 'lenders of last resort' empowered to issue fiat money in unlimited amounts, nearly every participant in the financial markets is highly leveraged. Extant financial liabilities at all times exceed the amount of money proper and perfect money substitutes in the system by nearly an order of magnitude (in other words, there is far more debt outstanding than there is money to pay it with). When the rush to pay back debt is on, asset prices everywhere come under pressure, usually in a manner that mirrors the degree of leverage employed by market participants holding the assets concerned. As every seasoned market observer knows, intra- and inter-market correlations tend to increase markedly when such crisis situations become acute. In short: there is no such thing as a 'contained' financial crisis.
As a further comment on the Bloomberg article quoted above, it appears to us that Mr. Tremonti's fall from grace is directly related to the political and legal troubles that have lately ensnared his boss, prime minister Berlusconi. As Berlusconi openly stated, “he would make sure the austerity package was changed during its passage through parliament to make it more attractive to voters rather than markets”. In other words, Berlusconi is eager to bribe the electorate and buy votes by altering what are regarded as unpopular measures. To quote the infamous lover of Louis XV of France, Madame Pompadour on the topic: 'Après moi, le déluge'.
It is a fundamental problem faced by democracies that everybody tries to live at the expense of everybody else. Politicians have only limited spans of office, and their interest in maintaining the accumulated capital of the nations they govern is close to zero – after all, this capital is not their own property. Short-run pain is thus always avoided, regardless of the long-run consequences. No wonder the political class has seized approvingly on the ideas of the most dangerous economist the Western world has ever been blighted with, who once famously quipped that 'in the long run we're all dead'.
Berlusconi may well be underestimating how far away said long-run consequences of irresponsible short term oriented polices are. It rather seems to us that the long run consequences have arrived, and we're all still alive to 'enjoy' them.
Friday's continued blow-out in Italy's government bond yields is testament to this fact. On Friday evening, we went to a traditional meeting of a group of like-minded supporters of free markets and sound money, and in a conversation with a friend who is a fund manager in our neck of the woods, a thought occurred to us that is probably worth sharing in this context: when Italy's bond yields initially broke out to a new high, this fact was scarcely remarked upon in the financial press. Indeed, apart from ourselves and perhaps Mish, who also keeps a close eye on what is happening in Europe, most observers seemed to ignore the event. To our mind this actually underscores its significance. Any development the importance of which is not widely recognized, harbors a much greater subsequent 'surprise factor' – you could perhaps also say that its 'black swan coefficient' is greater than it would otherwise be, or in Italy's case it would probably be better to call it a 'gray swan coefficient'.
An interesting factor is also what Mr. Badiani quoted by Bloomberg above calls the potential 'change in the pecking order of euro area contagion' that the recent events are beginning to suggest. Hitherto it was widely assumed that Spain was more likely to 'fall' before Italy, but this may no longer be true.
As a final comment on Tremonti, he was apparently caught on tape last week calling one of his cabinet colleagues a 'cretin' (video). The subject of this description was Public Works minister Renato Brunetta. We don't know Mr. Brunetta and can therefore not really say whether he is or isn't a cretin, but since he is 'Public Works' minister (this type of ministry sounds like a leftover of the Mussolini era), it seems likely that he was resisting Tremonti's budget cutting efforts. Moreover, most politicians are cretins by nature of the occupation as such, so the probability of a specific member of the political class actually corresponding well to this description must generally be considered to be quite high. As we have pointed out previously, we think a politician's entertainment value is the most important criterion by which to evaluate him. There are a few notable exceptions to this rule in countries where classical liberalism still has a constituency, and we would name Ron Paul as the best example for such an exception (i.e., we value him for his political agenda and honesty rather than his entertainment value)…
