Italian Elections and German Government Talks Could Spark Financial Crisis
The Dow Jones seems determined not to return to the 26,400-point high it reached last January. It’s as if there’s a barrier that investors aren’t ready to cross. It’s not surprising; even the most stubborn of bulls are having to recognize that the stock party is over.
The risks set from the tax cuts and internal politics in the United States could already be leading to a financial crisis. But the political winds blowing in Europe could deal the final blow, triggering a deep stock market crash.
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Europe is afraid. So should be the United States, and not because of the new armaments and missiles that Russia’s President Vladimir Putin has announced he would not hesitate to use, should anyone attack Russia or its allies (which includes Syria, Iran, China, and Venezuela). The key date to look for is March 4. The events of that day in Italy and Germany could trigger significant and negative reactions in the financial markets.
Yet, if the internal risks to the U.S. economy—including the risk of a major stock market crash—weren’t scary enough, there are two major risks from Europe.
Why Care About Europe, You Ask?
A simple reason to care about Europe is that the European economy, in the sense of the eurozone, is the world’s second-largest and richest by far. China is the world’s largest economy. In 2016, its gross domestic product (GDP) was $21.3 trillion. The EU followed at $19.2 trillion. The United States was third at $18.6 trillion. The EU and China combined produced almost 34% of the global economic output in 2016. (Source: “What Is the World’s Largest Economy?” The Balance, October 25, 2017.)
What happens in the rest of the world is a crucial U.S. concern, especially if President Donald Trump wants to fuel U.S. economic growth, increasing exports.
Two elections are threatening stability in Europe in 2018. One of these is the German election, which was held in the fall of 2017, yet the results were so uncertain that no party won enough votes to lead by itself. The fact that a far-right party, Alternative for Germany (AfD), enjoyed a little too much electoral success for many Germans’ taste is forcing unlikely allies into a difficult coalition.
The Social Democratic Party of Germany (SPD) will deliver the verdict of an internal referendum on March 4. Should the vote be “Yes,” Germany will return to the Grosse Koalition (Grand Coalition) with Angela Merkel’s Christian Democratic Union of Germany (CDU).
Merkel would retain the post of chancellor (the equivalent of prime minister), but she would have to relinquish many crucial government posts, from the economy to foreign affairs, to the SPD. Should, as some expect, the SPD and the CDU prove unable to come to a deal, be prepared for a substantial stock market correction in the week that follows.
German Instability and Financial Collapse
Such a scenario would plunge the largest driver of the EU economy into an unfathomably deep political crisis (by German standards, anyway). And that’s part of the problem. The world is not used to Germany having to endure political instability. Even its reunification in 1990 occurred with excitement but little drama. But the prospect of a far-right party re-entering the Reichstag in Berlin, in an atmosphere of growing xenophobia, scares many Germans and other Europeans.
Perhaps in the market climate that prevailed in the final weeks of 2017, stocks would have absorbed the impact of such circumstances. Now, with U.S. interest rates potentially going up four times in 2018, many investors will be rethinking their strategies. Expect the higher rates to push many away from higher-risk equities and related financial products to safer assets like precious metals, gold, and silver, or other commodities.
The Bigger Risk From the Italian Elections
The other risk to the U.S. economy—and the global economy, in fact—comes from the Italian elections on March 4. If Germany doesn’t worry you, Italy is agitating the European Commission (EC) and the main European stock exchanges.
Italian elections are complex in the best of times; the 2018 ones risk producing a situation of a complete stall. Similarly to Germany, the problem is that Italy, which is Europe’s second-largest exporter and industrial power, risks ending up with no government. In Germany, at least, there are two main parties willing to talk and come together to form one. There are no such assurances in Rome.
The best that can be surmised now is that the vote will produce one of three possible outcomes. The most likely of these features a name that will scare investors from all corners of the world away from Italy (and Europe). Yes, it’s the unsinkable Silvio Berlusconi, the man who makes Trump look like a mere amateur of political chaos.
I’m Back…
Berlusconi would return to power should the center-right coalition, of which he’s a leading member, win and manage to stay united. Berlusconi ally Matteo Salvini of the Northern League, a far-right political party, could cause much turmoil, given the party’s anti-immigration stance.
Ironically and sadly, a Salvini-Berlusconi victory would produce a government in the shortest possible time and with the fewest obstacles—even if most Italians would be shaking their heads in bewilderment.
Italy has a largely proportional electoral system, which fractionalizes vote results among a myriad of parties. This allows a party that gets 20% of the vote to aspire to form the next government. European markets will not welcome this solution, but they won’t crash either.
Unlike the other parties, the center-right coalition has been planning for months. They are largely populists who have already formulated and signed a platform. They have also already decided who would become prime minister in the case of a victory. In this sense, even Germany can’t criticize. They are still negotiating their coalition formation after months of political limbo.
Berlusconi, arguably, could grab the most votes within the coalition. He’s the most centrist in it. Yet, because of infamous legal problems accrued during his previous terms in power, Berlusconi cannot become prime minister. He can only choose the prime minister. Some of the most moderate names, however, are not anti-EU enough for the others’ taste. Meanwhile, those close to Salvini are not only too anti-EU; they’re also too right-wing for the others.
Call Berlusconi what you want, but don’t call him a fascist. The second coming of Benito Mussolini he is not. Berlusconi is pro-EU and his party belongs to the same political group as Merkel’s Christian Democrats.
That’s as close as Italy can get to a stable and quick post-election government. The others may have more agreeable personalities, including the capable and honest outgoing prime minister Paolo Gentiloni. If the Berlusconi-Salvini bloc doesn’t achieve an outright victory, they will have to join forces to create a coalition with center-left parties, of which there are several.
The solution here might be a return of Gentiloni as prime minister. It would be the closest thing to representing a continuity with the outgoing government. Should this occur—it could take a few days—you will see a happy EC President Jean-Claude Juncker.
You could also expect a strong rally in European stock exchanges (especially if Germany gets its act together), which may translate to a rally on Wall Street. Naturally, given all the problems that this coalition will avoid, it requires a delicate weaving of deals among several parties. Moreover, it’s the kind of arrangement that is weak from the start.
Could U.S. Dollar Finally Have a Way Up Without Interest Rate Increases?
Such a coalition produces internal tensions that lead to fractures and a return to the polls in short order. The markets will be weary. After the initial stock rally, European markets could collapse in a limbo of their own, amid high volatility. Naturally, the euro would also lose some value, benefiting the U.S. dollar with or without Fed rate hikes.
Finally, what we might consider the worst possible scenario involves a victory for the Italian Five Star Movement (M5S Movement). They are the most anti-EU and the most volatile potential government leaders. They have already chosen their leader, Luigi Di Maio. He’s very young for a politician (about 31 years old) and inexperienced, having only ever been in opposition.
An M5S win, which is well within the realm of possibility, would be the equivalent of a Marine Le Pen win in France. The risks include—apart from the infiltration of a more xenophobic air at a time of intense movements of refugees and economic migrants—pulling out of the euro currency.
Look for a heavy market crash in European stock exchanges and in the euro currency if you hear the name Di Maio being thrown around as Italy’s next prime minister.
