The Italian economy is hitting headlines again, with no end in sight to its continuing problems. The Daily Express reported that the relationship between Rome and Brussels is deteriorating. The European Commissioner for Economic and Financial Affairs, Pierre Moscovici, has been accused of interfering in Italian politics by the Five Star Movement. This is because he attended the launch of the Democratic Party’s campaign for the European elections.

This row is more than about politics, but economics too. The Italian Government has committed itself to some expensive reforms that both the Five Star Movement and Lega campaigned on during their 2018 electoral campaigns. This year, politicians raised their spending budget for 2019 to 2.4 percent. The EU’s figure for spending limits is 3%. Whilst Italy’s expenditure is below Brussels’ target, they still urged Rome to cut its spending out of fear the country’s debts will expand further. Italy agreed to lower it to 2.04%.

The real reason why Rome is struggling to repay its debts is because of the EU’s Target2 system. Few know what this system is, but a nation must be a eurozone member to participate in it. As Nikolai Hubble outlined in his novel How The Euro Dies, Target2 is the system by which the various national central banks, the European Central Bank and Europe’s commercial banks interact. Massive transfers of funds are settled using the system.

Target2’s central goal is to ensure the eurozone remains stable. For example, when the Greeks buy German cars, Target2 is the system by which the money is sent back again to Greece in the form of a loan to rebalance trade. The Greeks owe the ECB and the ECB owes the Germans.

The problem with Target2 is that it ensures there is always a bailout mechanism for nations that fail to achieve a surplus. In 2012, Germany was in surplus and their money was used to bailout Portugal, Ireland, Italy, Greece and Spain. The system is designed to ensure northern European money flows to the south. Hubble calls it a lose/lose proposition as it robs countries with trade surpluses, like Germany, of their wealth. It prevents nations with a trade deficit, like Italy, from rebalancing their trade by leaving the eurozone and devaluing a new currency. Germany is essentially financing Italy’s debts, instead of using its surplus to generate wealth by buying foreign assets.

Italy’s debts have been growing since the 2000s, when the ECB stripped countries of their freedom to decide their own interest rates. The ECB kept them so low during that decade and Italians borrowed vast amounts of money that triggered this crisis. Today, debt to GDP has risen to 130%. The country is already facing a two trillion-euro financial crisis and the ECB can only buy 33% of a nation’s debt. This means there is only so much of it they can buy, and no one can bail them out. As a result, Italians will struggle to repay their Target2 loans to Germany. Hubble predicts they will have no choice but to default on their debts and quit the euro. If Italy is outside Target2, Germany is not guaranteed to have its money returned, which the system ensures happens. This could trigger a eurozone-wide recession if Target2 countries cannot repay each other and, as Hubble predicts, the end of the eurozone as there is no trade balance.

Target2 is inflicting significant damage on Italy’s economy and it is only a matter of time before they default on their debts. The wider implications of the Italian debt crisis are yet to be felt across the EU.

It's a tough moment
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