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The Political Dynamic in Italy Could be Good for Gold

Commentaries & Views

Italy’s debt to GDP ratio is amongst the highest in the world.  As the new government in Italy seeks to stimulate growth through increased borrowing, gold’s attractiveness as an asset which is not replicable and is no one’s liability will become more apparent.

Italians recently elected “protest parties” M5S and La Lega, largely due to economic hardship in the country.  Since the 2008 financial crisis, unemployment has risen while total GDP and per capita incomes have stagnated. 

Total debt to GDP has increased in Italy despite the fact that the government has been running a primary budget surplus for the past seven years as government expenditures have declined. 

New Italian prime minister Giuseppe Conte stated that the way for Italy to reduce its debt is through “growth and not austerity.”  Mr. Conte’s statement implies that Italy will likely seek to spark growth by reducing taxes and increasing government spending.  In fact, two policies floated by Italian government coalition members are a flat tax and universal income.

If the Italian government embarks on such policy measures and debt grows faster than GDP, yields on Italian debt are likely to rise as lenders demand a higher return for lending to a more indebted counterparty.  If rates rise to the degree that future borrowing is imperiled, and the new government faces a risk that it won’t be able to implement its plan, it faces three choices:

1.   Give up on its plan.
2.   Give up on the euro (repudiate its debt).
3.   Rely on the ECB to keep interest rates on its debt low by buying bonds with newly created money.

The Italian government is in a bind as it seeks to grow while having to endure the burden of a $2.6 trillion debt load.  Italy’s bind might become Europe’s as rising Italian bond yields force the European government to choose between printing money or allowing Italy to repudiate its debt and leave the common currency.

Italy’s debt problem is a microcosm of an over-indebted world.  If (when) other world economies start to slow, similar choices to Italy’s will have to be made.  Either print money to buy bonds and keep rates low, or default on debt.  In either scenario, gold will regain its shine as the asset which cannot be replicated at will and which carries no risk of counterparty default.  

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