“Italy could be out of the EU before Britain,” writes Jeremy Warner at the Telegraph.
I wish I came up with that line.
Instead, I’m rather worried the Italian and EU crisis will do the precise opposite. Brexit will be delayed on account of Europe’s chaos. Or Remainers will get the chaotic Brexit they warned about, but thanks to Europe’s implosion instead of a UK political stunt.
Yesterday’s market action was all about Italy’s chaos spreading to the global banking system.
EU banks are down more than 10% in four days and Italian banks more than 20% since mid-May. US banks tumbled more than 3% yesterday too, to six-month lows. It was the first time the Italian crisis jumped the Atlantic, reported the Financial Times.
The crisis is spreading.
The action in the bond markets continued too. The Italian two-year bond yield had its biggest spike ever, for example.
But bond yields are still low in absolute terms. And it’s stocks and banking systems which can really put the fear into people’s hearts.
Research by Eric Dor, the director of economic studies at IESEG School of Management, analysed which banks stand to lose the most from the Italian bond carnage.
The Italian banking system is obviously top of the list. But it hardly stops there.
BNP Paribas, France’s largest bank, has €16 billion in Italian sovereign debt. French/Belgian bank Dexia holds €15 billion of Italian bonds. And Spanish bank Banco Sabadell, which owns UK bank TSB, has €10.5 billion of the so-called BTPs.
Will these financial institutions watch their capital evaporate, or sell out now?
The choice between a government bond crisis and a banking crisis is a tough one…
Look for a crash on Friday
On Friday, the European Central Bank (ECB) releases its Target2 balances for April. This obscure financial account is at the centre of my prediction for Italy’s default and departure from the euro. You can find out how it all fits together here.
If the Target2 balances are revealed to be spiking again, as they did in 2012, I expect markets to tumble that day. Because it’ll bring northern Europe’s politics into the game with a bang.
Right now, it’s southern European threats of self-harm that are unsettling markets. “Are the Italians for real?” people are asking themselves.
If the markets realise that the other side of the equation isn’t looking promising either, things will really get out of hand. And that’s where Target2 comes in. I’m talking about how much back-door assistance northern Europe will bear before they close the door on the south.
You see, the monetary union comes with some very odd economics. It might look like the euro is some sort of borderless system, but it isn’t. It’s much more bizarre and complicated than you can imagine.
When money flows out of Italian banks to the relative safety of the north, the ECB system sends it right back south again. Target2 is the system which performs this. It keeps the amount of euros in each nation stable.
Without Target2, there’d be a sort of currency shortage in the south.
But that also means Target2 is a measure of capital flight. It tells you how fast Italians are getting their money out of the Italian banking system. It’s a canary in the coal mine.
The Germans, meanwhile, are in effect lending to Italy through the Target2 system. A departure from the euro would leave them high and dry for the amounts they’d sent south.
Target2 balances are like a one-stop shop for crisis indication. They tell you about capital flight, back-door bailouts and political pressure all at the same time.
No doubt the May Target2 imbalances will explode spectacularly. But I wonder what Friday’s release will say about April…
What would another financial crisis do to you?
Last month, I explained how the Italy crisis would unfold. So far, things are going according to plan. You can find out more about why Italy is suddenly cornered, and what happens next, here.
But what’s really at stake? If the stockmarket tumbles again, it’s the third time around in 18 years.
Can you afford it?
What would another crash do to investor psyche in Britain?
Most of all, what would another stockmarket crash do to the likes of pensions?
Our entire retirement system leans on financial markets. If they keep letting us down spectacularly, where does that leave us?
I’m writing this to you from Japan. People here used to invest for retirement too. These days, it’s seen as gambling. An indefinite bear market will do that to you.
If financial markets don’t deliver on their promises, will Brits give up on the stockmarket?
I think we’re going to find out.
Until next time,
Nick Hubble
Capital & Conflict
Category: The End of Europe