Italy is known for its chaotic and unpredictable politics. But an unsuccessful attempt to form a new government there helped cause a sell-off in markets globally on Tuesday.
The big fear with Italy? That it could abandon the common currency in the European Union (EU), called the euro, and ultimately leave the EU.
So what does Italy and the euro have to do with the global markets? Read on and we’ll explain.
First things first
Italy is governed by a parliamentary system. As opposed to the U.S., which has just 2 parties, Italy has six major parties, and dozens of smaller ones. The recently elected president, Sergio Mattarella, is charged with forming a government out of those parties, but he has been unsuccessful doing so.
This week, a coalition between Italy’s populist party called the Five Star Movement and the right-wing Northern League party, both of which are skeptical about the EU and the euro, selected a finance minister known for his anti-European Union and anti-euro rhetoric.
Mattarella rejected that candidate, setting the stage for a new round of elections, which could end with the ouster of Mattarella, and with the Five Star and Northern League gaining more seats in parliament.
The fear is that their gains could prompt Italy’s departure from the euro–although that’s still considered a long shot, by many experts.
What’s the Eurozone and the euro?
The EU is a coalition of 28 countries, primarily in Western Europe, 19 of which share a common currency called the euro, in a geographical region known as the eurozone. The euro is one of the major currencies of the world, along with the dollar and the British pound.
The EU began functioning as a single market in 1993. It has a central bank, based in Brussels. Since Italy’s currency is tied to the eurozone, it doesn’t have the power to devalue its own currency independently, which some experts believe could help it in the face of its current economic weakness.
Stash Learn Weekly
Enjoy what you’re reading?
What’s the Italian exit?
Italy’s potential departure from the EU has been dubbed Quitaly, and Italexit, names that mimic Brexit. Brexit was the momentous decision in July 2016 when voters in the United Kingdom chose to leave the EU. At the time, the vote also shook markets. The Dow fell nearly 1000 points in the days following that vote.
Italy would, however, have to change its constitution to leave the eurozone.
Why are markets wobbling now?
Italy is the third largest economy in the European Union (EU), and until recently, had been one of the strongest supporters of the euro. It was one of the first countries to adopt the euro in 2002.
The possibility of Italy abandoning the joint currency could undermine investor confidence in the shared currency and in the desirability of the eurozone for investment. Another outcome could be the unraveling of the entire EU, according to some reports.
Italy also has a serious debt problem. Its total public debt of $3 trillion is worth 132% of its entire gross domestic product, or GDP. (By way of comparison, U.S. public debt is roughly equivalent to its GDP.)
On Tuesday, many investors sold their Italian debt, causing the the interest rate on Italy’s short-term bonds to increase by 1.5 percentage points, to 2.42%. That means it will be more expensive for Italy to borrow going forward, which could deepen its economic crisis. In fact, Italy might require an extended bail out from the European Union, to rescue it from its indebtedness and extended economic recession.
First Greece, now Italy?
Greece, another member of the EU, also went through years of near total bankruptcy due to its escalating public debt. It required a bailout from Europe’s central bank worth billions of dollars.
There is some question whether the EU’s central bank has the stomach to take on another rescue package for Italy, one that is likely to need a much bigger amount of money.
Economic crises in large economies can tend to affect the global economy. In 2008, the economic crisis that began in the U.S. with subprime mortgages also spread around the globe, leading to years of depressed economic activity worldwide.
For now, however, the crisis seems confined to Italy. And financial experts suggest it’s important not to worry too much.
“I think investors are correctly looking at this as an Italy-specific risk for now,” Megan Greene, global chief economist at Manulife Asset Management told the New York Times.
Want to get wise about the financial world around us? Keep reading to become a smarter Stasher.