There is no pain-free way of leaving the euro. Photo / AP
There is no pain-free way of leaving the euro. Photo / AP
"Last night was the darkest in the history of Italian democracy," Luigi Di Maio, head of Italy's populist Five Star Movement, said on Tuesday. For once, this was not just Italian hyperbole. He's right, but not entirely for the reasons he meant.
It is indeed a profoundly threatening moment, not just for modern Italy, but for the European Union as a whole.
Not because the Italian President, Sergio Mattarella, has ridden rough-shod over democratic convention by blocking the appointment of a Eurosceptic Finance Minister, or because he has turned to Carlo Cottarelli, a former big wig at the International Monetary Fund, to form a caretaker government; something similar has happened before in the bedlam of Italy's political circus.
Rather, it is because the current incendiary confluence of political, financial and economic forces is a much more dangerous mix than anything we have seen before in the single currency's troubled, near 20-year history, threatening to blow the whole thing apart from within.
It is impossible to imagine the euro, once the rebellious Italians have been cut loose, sailing on regardless as if nothing had happened.
If Berlin honestly believes this, then it is living in a parallel universe. The loss to creditor nations - of which Germany is by far the largest - would in itself set in train a whole sequence of political uprisings.
And if it is the end of the eurozone, then it is also curtains for the European Union. This might be regarded as cause for celebration among some Eurosceptics. Brexiteers would think it vindication of Britain's decision to leave.
They should be careful what they wish for; the political, financial and economic fallout from a disorderly unravelling of Europe's post-war settlement would make the financial crisis look but a stroll in the park by comparison.
Italy's populist leaders shake their fists at the widening spreads, as if they were the very personification of the establishment conspiracy they believe has floored a once glorious nation. Europe's political elites have given them plenty of reason to believe it.
"The markets will teach the Italians to vote for the right thing," Günther Oettinger, European commissioner for budget and human resources, commented, as if deliberately shooting himself in the foot.
If he had casually opined that all Italians were lousy footballers, he could scarcely have said something better designed to incite.
Five-Star Movement leader Luigi Di Maio meets reporters at the Italian parliament, in Rome. Photo / AP
But markets have of course never been at the beck and call of the politicians, neither those who want Italy to be punished for voting the "wrong way", or those who habitually harangue the financiers of London and New York for failure to do their bidding or bankroll their hair-brained policy initiatives.
Rather, they are governed by the self-interest of millions of investors and money managers.
And what they see is an environment about to turn entirely hostile to wealth preservation and growth - a situation which is politically much more serious than the Red Brigades in the Seventies, when the middle classes were united against the violence, and far more dangerous financially than the height of the eurozone crisis under Silvio Berlusconi, when a technocratic government was allowed to step into the breach to calm things down.
Even if the Five Star/League alliance doesn't increase its vote in the next election, the centrists are so hopelessly divided that it is impossible to think of them as able to form an alternative coalition.
There may still be time for the eurozone high command in Brussels and Berlin to prevent the impending road crash.
But they can only do so by cutting Cottarelli some slack, and loosening the fiscal straitjacket accordingly.
Precedent would suggest that this is indeed what the eurozone will do. At every stage during the euro's ongoing crisis, Berlin has drawn its lines in the sand, only to see each one breached in an attempt to save the single currency from collapse.
Similar band aids will surely be applied this time, allowing the centrists to regroup and pull Italy from the brink.
The alternatives look bleak. Once markets cease to believe in the possibility of political solutions, things will quickly play out.
Spreads will widen dramatically back to where they were at the peak of the eurozone crisis, making it hard to impossible for the government to fund itself in debt markets.
It is indeed a profoundly threatening moment, not just for modern Italy, but for the European Union as a whole. Photo / AP
Who in their right mind would buy Italian treasuries given current uncertainties? One answer to that question might be the European Central Bank, through existing central bank asset purchase facilities or by activating so-called "outright monetary transactions".
This might help a bit, but the OMT option is only open to programme countries that have agreed challenging fiscal targets and reform agendas.
This is precisely what Italy is rebelling against. In any case, it seems likely that matters would come to a head well before we reached that point.
The ECB would also face strong resistance to increasing its exposure to a country whose forthcoming election is likely to be a proxy on whether or not to stay in the euro.
As Italy's populists charge headlong towards the cliff, they drag the whole edifice with them into a world of mass default.
In such circumstances, the so-called "doom loop", whereby impairment of sovereign debt infects the solvency of the banking system through its holdings of Italian treasuries, would soon return. Already there is evidence of capital flight, forcing Italian banks to draw ever more heavily on central bank liquidity.
This in turn increases the size of the potential liability in surplus nations such as Germany and the Netherlands.
Alarm bells are ringing loud in Frankfurt, where the Bundesbank Target 2 balance will shortly breach the €1 trillion ($1.7t) mark. In the event of a collapse in the single currency, this money would be lost to Germany, the greatest wipeout of middle-class savings since the Second World War.
The Eagles' Hotel California - you can check out any time but you can never leave - has been much used as an analogy in Britain's Brexit negotiations.
If true of the EU, it is doubly so of the euro. There is no pain-free way of leaving the euro. If the intention is announced, the markets will massacre Italian assets and overnight bankrupt the country.
If preparations are made in secret, it amounts to the same thing; as soon as the markets suspect, the country will become subject to a catastrophic run.
The Varoufakis idea of a parallel currency - or mini-BOT - is similarly flawed. No one outside Italy will bank it except at massive discounts, and if seen as a staging post to eventually leaving the euro, there would again be a stampede for the exit, forcing the pace of events.
Liberal elites have brought this calamity on themselves. By refusing to listen, and reform accordingly, they double down on their mistakes.
As Italy's populists charge headlong towards the cliff, they drag the whole edifice with them into a world of mass default. Who knows what comes next, but the way things are going, Italy could be out of the EU before Britain.
