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Italy: When Hope Is a Strategy

By  +Follow July 2, 2014 12:48PM
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I came back from Italy this week, and one of my guilty pleasures was being able to sit down and watch the last three episodes, including the season finale, of Game of Thrones. For those readers who are not enthralled with the fantasy epic from HBO or have not read the first five books (will he ever finish?), author George R.R. Martin has written one of the most complex fantasy series ever, about a world where everyone is occupied with who will sit on the Iron Throne.

It is a land of numerous countries and cultures, where the average person might just enjoy a little peace and quiet but where their leaders are seemingly always ready to go at one another, dragging their armies behind them, whether at the hint of an insult or the prospect of the ultimate prize. The series is utterly unpredictable, as Martin seems to routinely to kill off both protagonist and antagonist alike with unexpected finality. You have to be careful not to become too involved with any of the characters, as fate (i.e., the author) can pluck them from the scene all too quickly. Plot twists abound in every chapter, and seemingly minor characters can become major players as time unfolds.

In other words it’s a place not unlike Europe.

After spending a few days in Rome trying to deepen my understanding of the situation in Italy – which of late has seemed as convoluted as the plot from Game of Thrones, mercifully minus the swordplay but with about the same level of spectacle (who could come up with this cast of characters?), I think I have perceived what might become a significant plot twist in the offing.

So let’s look this week at what I uncovered in Italy, which rather surprised me, and think through some of the implications that the new developments suggest for the ultimate outcome of the euro project.

(I want to acknowledge up front the significant help of Christian Menegatti and Brunello Rosa of Roubini Global Economics in setting up key meetings with politicians, bureaucrats, and the Italian central bank. I am also grateful for the candid conversations we had after the meetings, as we tried to work through what we had heard. While this letter will not present a consensus view of our meetings and conversations, I did learn a great deal more than if I had simply gone on my own. Thanks, guys. (They of course are not responsible for any mistakes or inaccurate predictions herein. I can make enough of those on my own.)

Game of Thrones, European-Style

What surprised me about Italy was the emergence of something that felt like speranza, which I am told is the Italian word for hope. On my previous visits to Italy over the years, I have seen frustration, anger, and resignation – generally, there was a feeling that there was very little anyone could do to really change things. Even though the names and personalities and even governments changed, there was an underlying assumption behind every conversation that simply said, “This is the Italian way,” especially when it came to doing business. Government was slow and inept and bureaucratic; it took years or decades to get anything through the courts; and that’s just the way it was. Italians have displayed a marvelous aptitude for getting things done in spite of government, not because of it.

Italy, and especially the north of Italy, is a manufacturing powerhouse; and while it’s not the export behemoth that Germany is, the Italians do quite well, thank you very much. It is a testimony to their entrepreneurial skills and design talent that they have done as much as they have, given the ineptitude of their government. That might seem a little harsh, but I think you could find more than a few Italians who would agree.

But something different seems to be happening now. In the last European elections, a clear winner was an upstart politician in Italy. The EU Observer explains what happened:

In June 2013, Matteo Renzi was still pretending that his greatest ambition was to serve a second mandate as mayor of Florence, a mid-sized town of less than 400,000.

A year on, he is rubbing shoulders with the likes of Barack Obama at G7 summits, and is emerging as the biggest counterweight to German Chancellor Angela Merkel on the EU political landscape.

A historic win in last month’s European Parliament elections, where his Democratic Party (PD) took 40.8 percent of votes – the best-ever result for the Italian left, and the highest score ever recorded by a single party since the Christian Democrats in 1958 – has given him a strong hand to challenge Berlin-backed austerity policies, as Italy takes on the EU’s six-month presidency on 1 July.

“He has meticulously planned his rise to the top for the past 10 years. Not many people, be it in politics, journalism or business, have the same tenacity, drive and determination that he has displayed,” says David Allegranti, a political reporter from Florence who has written two books on Renzi. In February, the 39-year-old became Italy’s youngest-ever prime minister.

Renzi is photogenic and charismatic, but most of the commentary I read prior to going to Italy three weeks ago seemed to dismiss him as just another one in the series of soon-to-be-sacked Italian prime ministers, there having been four in as many years. Given the current volatility of Italian politics, it seemed just a matter of (not very much) time before Renzi’s government would fall. The only question was what might emerge next from the sausage grinder of Italian politics.

In a little bit we’re going to cover in detail some of the rather serious economic realities that face any Italian government. The challenges are daunting, and heretofore the system seemingly just hasn’t been properly designed to deal with them. With a debt-to-GDP ratio of over 135%, simple interest costs of 5% of GDP, ultra-low inflation, high unemployment, low to no growth, and rising debt, Italy’s economic problems are all too real.

So where is the hope coming from? Renzi is not just going after the economic troubles. He seems to be attacking the very deep structural issues in a novel way. He is seeking serious constitutional reform in a country that has seen no constitutional changes for 30 years. Changing the constitution is difficult and requires a super-majority, which Renzi does not have. But when you meet with Parliament members and ministers from Renzi’s party, there is an optimism that is almost catching. Somehow or another Renzi has convinced a lot of people in the Italian political system that reform is possible. In particular, he wants to do away with the upper house (their senate) and streamline the decision-making process in the remaining house of Parliament, with different rules for creating majorities.

Further, he is looking to reform the judicial process in a way that will allow court cases to actually be resolved in a realistic timeframe, removing the “justice delayed is justice denied” issue. Of course, labor reforms are also on the docket.

Meeting with ministers and government leaders who are involved in developing the budget, I found acknowledgment that the only way they can get out of their current situation is to grow their economy. They admitted they needed 2% real GDP growth, 2% inflation, and a 4% “primary surplus” (more on that later). They candidly acknowledged that this outcome is possible is only with significant outside foreign direct investment, substantial growth in exports, and a drop in the unemployment rate. “We have to unleash Italian industry and business.”

The current system discourages foreign direct investment and is actually chasing Italian businesses from Italy. The recognition that things need to change if there’s going to be any progress in the economy is widespread across the spectrum of political views.

Renzi is seemingly unafraid of pressing ahead on multiple fronts and is perfectly willing to see his government fall and to then hold new elections as a referendum on his policies. For a center-left politician, he is forging political pacts and alliances with an odd cast of characters.

I think the mood can best be summed up by a snippet from a conversation I had late one evening. I was talking with a successful businessman and long-time nominal conservative supporter who told me that he had recently picked up his 18-year-old son at the airport, as the young man returned home from college in another part of Europe. He came back on the day of the recent elections, and as his dad was driving him to the polls, he asked, “Papa, I really don’t understand anything about this election, as I’ve been away. Whom should I vote for?” His father told him to vote for Renzi.

To continue reading this article from Thoughts from the Frontline – a free weekly publication by John Mauldin, renowned financial expert, best-selling author, and Chairman of Mauldin Economics – please click here.

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DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions.


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By  +Follow July 2, 2014 12:48PM
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