On Sunday evening, during a somewhat bizarre interview with Fox News, Donald Trump underscored his economic bonafides.
Not really. He made a fool of himself. As usual.
“When I took it over, we were headed south”, Trump said, in terms that suggested he gained dominion over the US economy by force. “Our GDP would have been very negative”, he continued.
If you don’t understand why that latter quote is absurd, you may be a Trump voter.
But Trump-o-nomics has its adherents. Or maybe that’s not the right way to think about it. Maybe it makes more sense to say that Trump’s authoritarian leanings have led him to accidentally adopt the kind of economic management style you’d expect out of dictators.
The insistence on fiscal and monetary policy both having a pro-cyclical bent is indicative of an overriding desire to overheat the domestic economy, irrespective of the consequences, in the service of inflating the executive’s ego and strengthening his or her grip on power. Trump benefits from the dollar’s reserve status and the world’s purportedly unassailable faith in the creditworthiness of the US government. There are shades of modern monetary theory in Trump-o-nomics, which is supremely ironic given that MMT’s political champions are some of the president’s most ardent critics.
It’s a somewhat odd setup that Trump stumbled into without realizing it. Much as his view on executive power has been shaped by his trials and tribulations in the Oval Office, Trump’s views on fiscal and monetary policy are an outgrowth of the realization that his over-the-top campaign promises vis-à-vis the economy are unachievable absent deficit-funded stimulus and a brand of monetary accommodation normally reserved for outright crises.
Much as Trump’s assaults on the press and efforts to erode democracy have emboldened dictators, his economic agenda has lent credence to calls for expansive fiscal policy in other nations. His ham-handed attempts to bully the Fed have oddly had the effect of legitimizing calls for deficit monetization. All of that from a so-called “conservative”.
One person who’s enamored with Trump’s economic agenda is Italy’s Matteo Salvini, who has cited the US president on a number of occasions lately in the course of tempting fate by suggesting he’ll flout EU budget constraints. Salvini has ratcheted up the rhetoric recently ahead of the EU elections. During his speech in Milan on Saturday, he alluded to Trump’s economy as a prototype for Italy.
Read more: Market Sours On Italian Assets As Salvini’s Budget Broadside Adds Insult To Injury
On Monday, Salvini reiterated calls for changes to EU limits. “The only way to relaunch jobs is to reduce taxes, so we need to change some European rules and some limits imposed by Brussels”, he said, during an interview with La7 television. He also insisted that Brussels accommodate his 15% flat tax.
Later, in remarks cited by Ansa, Salvini declared: “What I care about is a Trump-like revolution.” League, he said, will not back any VAT increase as long as he’s in power.
Earlier in the day, Italian Cabinet Secretary Giancarlo Giorgetti, an adviser to Salvini, accused Premier Conte of being “an expression” of Five Star. That reinforces the idea that Conte’s decision to back Luigi Di Maio’s successful effort to oust Armando Siri emboldened Salvini by giving him an excuse to cast the Premier as a meddlesome irritant.
Asked about Giorgetti’s comments, Salvini said he “absolutely” backs Conte. Nonsense.
One way or another, Italy is headed for a scenario where Salvini consolidates power. When it comes to fiscal policy, it’s clear what that will mean: A Trump-like agenda, for better or worse.
We can all debate the relative merits of trying to replicate the US example without a hostage central bank. It’s probably inadvisable. But it’s at least possible that an economy under Salvini’s control would be preferable to the current setup, where Italy is torn between left-wingers and right-wingers, with no way to meet in the middle.
Irrespective of how things end up, the road will be bumpy. “In [the] coming months, a number of challenges and risks have the potential to weigh further on Italian asset prices”, Goldman wrote in a recent note. Here’s a useful timeline:
(Goldman)
After noting that the Italian economy did manage to stabilize in Q1 (averting a third consecutive quarter spent mired in recession), Goldman cautions that their Current Activity Indicator is still negative. “Pressures on Italian assets may further weigh on confidence, and on banks’ balance sheets, asset quality and ability to lend”, the bank says, adding that “lower confidence and tighter credit conditions pose downside risks to our forecast for weak growth.”
More specifically, Goldman warns that drafting a budget which somehow toes the line between placating nervous markets, pacifying ratings agencies and keeping the economy from sinking back into recession is no easy task. In fact, Goldman says it might well be harder than it was last year. “This is because Italian public finances have worsened, while the current coalition continues to favour deficit-financed tax cuts and current public spending is increasing, with, in our view, insufficient supply-side reforms on the agenda to increase potential growth”, the bank warily recounts.
The real problem, though, is the same as it ever was: Italy is destined for another budget fight with Brussels and Salvini’s recent rhetoric underscores the inevitability of a clash. Here’s Goldman:
Third, the “budget season” is likely to highlight once again the differences of opinion on fiscal policies between the Italian government and the European Commission and lead to investor concerns similar to those that emerged last year, both on Italian fiscal risk and on Italy’s commitment to the European project. Based on the European Commission’s Spring 2019 forecasts, we think the EC is likely to recommend the initiation of the Excessive Deficit Procedure if corrective measures are not implemented in the 2020 budget law. We expect the Italian government to initially push back on the EC’s demands. In our view, only with the passage of time and further market pressure will this government, or any other alternative government, take fiscal measures to halt the rise in public debt as a share of GDP.
After detailing the risk of ratings downgrades (which would obviously become more likely in the event market sentiment sours), Goldman brings back in the dreaded sovereign-bank “doom loop” and in the process sounds the alarm on BTP demand.
“Italian banks were lenders of second-to-last resort last year and their holdings of BTPs are now close to a historical high”, the bank says. “Foreign investors continued to be net sellers of Italian bonds until February, the most recent data available.”
(Goldman)
Therein lies the problem with thumbing one’s nose at fiscal discipline without a hostage central bank. The ECB could effectively force a banking crisis in Italy any time it chose simply by allowing spreads to widen.
Clearly, this situation is tenuous and will become more so if exogenous factors (e.g., the trade war) continue to weigh on the outlook.
The risk is that Salvini continues to push the envelope without making a clear power play, leaving markets in the lurch and forcing already spooked investors to assume that the current fractious domestic political environment isn’t likely to improve any time soon (where “improve” here means Salvini forcing a shakeup that leads to a more stable coalition).
“On the one hand, polls suggest that Lega has an incentive to trigger a split in the current coalition, leading to a general election before its popularity falls”, Goldman goes on to write, before speculating that because “this has not happened so far could also signal [Lega’s] unwillingness to form a coalition with Forza Italia and its belief that the European fiscal rules will be relaxed after the European elections.”
Of course, if that turns out to be a miscalculation (i.e., if the EU does not adopt a more forgiving stance towards Italy’s fiscal and economic plight), Salvini’s popularity could wane amid further pressure on Italian assets and a possible double-dip recession. At that point, the opportunity to rid himself of the current awkward alliance with Five Star may be lost.
All of this argues for Salvini to move sooner rather than later if he wants to, as Bloomberg put it earlier this month, be Italy’s “very own Donald Trump” with regard to economic policy.
