In yet another unintended consequence of U.S. tax cuts, Italy’s President officially dissolved parliament yesterday.  This ups the time table for new elections, which were originally thought to happen in May.

To forestall the worst effects on voters from the change in capital flow which will begin on Monday when U.S. tax policy changes officially, the Democratic Party in Italy pushed elections up nearly two months to March.

Elections in the European Union are always held to maximize the prospects for maintaining the status quo.  And this situation with Italy is no different.  Support for the Democrats led by Prime Minister Paolo Gentiloni has collapsed while former PM Silvio Berlusconi’s center-right coalition led by Forza Italia has surged in the polls.

Beppe Grillo’s Euroskeptic Five Star Movement is currently polling second.  And that’s the rub.  What’s feared is further erosion of the Democrats which would make it difficult for Berlusconi to forge a coalition between the Center Right and the Democrats, freezing out Five Star.

This dynamic is no different than what is playing out in Germany where Alternative for Germany (AfD) is frozen out of all coalition discussions despite earning more than 12% of the vote and coming in third overall.

With economic conditions falling rapidly thanks to the euro at $1.19 making an already moribund Italian economy even more uncompetitive, voter backlash could tip too far towards Five Star for an Italian version of the Grand Coalition in Germany (center-right plus far-left Social Democrats) to be possible.

In Germany elections were put off as long as possible to allow Angela Merkel to sell anger at Poland and Hungary for not observing migrant quotas after she stopped influx into Germany at the beginning of the year.  But voters saw through that, in the end, and support for AfD’s anti-immigration stance grew.

And Merkel limped to her current Vichy Chancellor status with no hope of forming a government and no direction other than maintain the EU’s current collision course with economic and political reality.

That reality is an abyss staring back out at them from Rome.

Because the situation in Italy is acute.  Italian GDP is 6% smaller than a decade ago, youth unemployment is a ridiculous 35%.  It is simply an uncompetitive environment trapped within a euro that is, at least, 20% too high for the Italian capital structure.

And all Germany can do is argue for more fiscal responsibility as it squeezes more blood from Southern Europe, strangling any hope of growth while preaching something even it doesn’t practice.

Never forget that Germany is running a Debt to GDP ratio of 82%.  Yes, Italy is mismanaged.  All of Europe is mismanaged. But, the solution is not higher taxes to pay off the crushing debt load coupled with spending cuts.  The solution is lower taxes, and a mixture of debt forgiveness/restructuring and lower government spending.

That is what is going to sell to an Italian electorate which has a tenuous relationship with its government in the first place.

Berlusconi, who was removed from office in 2011, after threatening to take Italy out of the euro, is now in the position to play king-maker.  He’s backed off from talk of leaving the euro, as all the Euroskeptic parties have.  Even the secessionist Northern League has moderated its rhetoric.

So, the question is has he made a deal with Brussels to not rock the boat too much and herd the Italians past what is a major hurdle for the EU in 2018?  Will he talk tough on the campaign trail but fold the moment things get tough?

Remember the Northern Leagues referenda earlier this year.  Those results will put a lot of pressure on any government formed to negotiate hard for Italy’s economic freedom from Brussels.

The same goes for Beppe Grillo and Five Star.  Are they all moderating their speech in the run up to the election to 1) gain votes and 2) allay the worst fears of the financial markets?  Because if Five Star were to upside surprise in March it would definitely not be well received by the markets.

Berlusconi, warts and all, will be much better received.  He’s much more the establishment politician who will cut deals.

The key for Brussels is for Five Star to be kept low enough that the Grand Coalition can be pulled off, but if it cannot be, then we will have a mess in the Italian debt markets in April.

Because the fundamental point here is that Italy’s banking system is insolvent.  And with the ECB trapped at negative rates and monetizing debt to keep asset prices from collapsing, a crisis of political confidence is the last thing anyone needs.

As I pointed out earlier, the U.S. tax cut that goes into effect on Monday will have an enormous effect on capital flow around the world.  Italy will wake up on Monday even less competitive that it is today.

Pushing the election up to March is a move to minimize the effects of that and Merkel’s inability to form a government in Germany.  The best Brussels is hoping for is a hung parliament election which keeps the current dysfunctional one in office for as long as possible.

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