As the Italian election season heats up it’s clear that Silvio Berlusconi is right where he wants to be.

In the spotlight.

And because of that, his coalition with the Lega Nord (Northern League), while leading in the polls overall isn’t unified on much more than containing the electoral success of Movimiento 5 Stelle (5 Star Movement, or M5S).

As I talked about over the weekend Lega Nord’s candidate, Matteo Salvini, is moving farther along the populist route, declaring himself a Trump-like change agent while excoriating the EU for its immigration policy.

On the other hand, Berlusconi is tempering his tone with each passing day.  First it was not leaving the euro, so-called Italeave, and more recently EU rules on budget deficits.

Ultimately, that’s Berlusconi’s job, to sell the EU to an Italian electorate reaching their breaking point.

M5S, the most radical of parties is leading the polls with anywhere from 26 to 30% overall.  No other party including the Democrats of sitting Prime Minister Paolo Gentolini comes close.  In fact, the Democrats are looking at support dropping below 20%.

Leaving the euro is supposedly only backed by 30% of the people.  Brexit was supposed to fail by 10-12 points and Hillary had a 98.5% chance of winning on election day.

So, while Italy’s new rules for the make-up for parliament almost guarantee a minority government, there is still a possibility of a grand coalition, similar to what Martin Schultz and Angela Merkel are trying to swindle voters into accepting in Germany.

But, the problem for Berlusconi and the Democrats, if that is their plan, is that it’s becoming obvious he is their stalking horse in this election.

He and Salvini do not see eye to eye on the subject of the euro, taxes, immigration or much else.

Euro-nly a Pawn

Salvini is out there stumping that the euro is a ‘crime against mankind.’

Mr Salvini said: “I believe that one single currency for 18 economies, each different in its own way, just won’t work in the long term. But statistics here is more important than anything else.

“Since the introduction of the current currency, Italy’s debt has risen by €900bn. This experiment has failed and we should not go any further down this road.”

And he’s right.  But, the reality is that, as of right now, exiting the euro is not a winning political talking point.  Everyone is backing away from it while at the same time, everyone knows it’s in Italy’s best interest.

Including Germany.

Let’s say the current situation holds and Berlusconi and Salvini limp across the finish line with around 40% of the vote, while M5S takes 30% and the rest is divvied up between the Democrats and minor parties.

Then, with the changes to the representation rules in parliament Berlusconi could easily cut a deal with the Democrats for a Grand Coalition that sells out Italy to Brussels. But, Salvini will still wind up as Prime Minister.

Regardless of how far Lega Nord has come to become a national party, Salvini will still be backed directly by a far smaller percentage of the population than M5S’s Luigi De Maio.

So, despite Berlusconi’s best maneuverings, politically, it still leaves Italy with a very weak government, which may be the point.

The difference here is that M5S will have a strong enough voice to support Salvini in any debt relief negotiations with Germany, which will have to come to pass this year.  AfD in Germany only got 13.5% of the vote. They are the official opposition.  But, M5S is the front-runner being obviously squeezed out by politicians loyal to Brussels first and Italy second (if that).

And the door opens up for him to go to the people and make the case for Italeave after dealing with Brussels.  All he has to do is invoke how Greece was treated in 2015.

Italeave Trumps Grexit

Because if Germany tries to play the hardball tactics it did with Tsipras, it likely won’t work in Italy.

Tsipras didn’t expect to win.  He wasn’t prepared for the game.  His finance minister, Yanis Varoufakis was. But Tsipras sold him out and enslaved two generations of Greeks to a debt yoke that is choking the life out of the country.

Salvini, if elected, will be facing the same thing. But will have support from Five Star Movement.  So, it will be very hard for him to betray Italy to Brussels the way Tsipras did Greece.  In fact, the path of least resistance for him is to call the EU’s bluff and allow the Italian Banks in trouble to fail.

This throws the decision back to Brussels to deal with the problem.

Because remember one thing, Salvini is right, Italy’s debt is 134% of GDP.  Most of the Italian banks are dealing with portfolios with NPLs (Non-performing loans) that top 40%.

Italy’s banking system is in terminal decline.

The European Central Bank has been propping up the price of Italian sovereign debt as the only effective buyer for nearly a year now.

italy debt

Something is going to have to happen.  And if Salvini and Berlusconi continue at loggerheads over basic issues like retirement, taxes and spending, then the market is not going to look upon that kindly and will continue selling Italian debt.

Let’s not forget that the ECB will be forced by The Fed to end its bond-buying program and allow rates to rise.  So, when, not if, Italy’s debt situation becomes untenable and another crisis breaks out Salvini would be in a very good negotiating position.

Why?  Because of the old adage then when you owe the bank a thousand dollars it’s your problem.

But when you owe the bank $2 trillion dollars it’s the bank’s problem.

And the bank in this case is the ECB along with most of the rest of Europe.  The only reason anyone still owns Italian debt is because the ECB has been a buyer.  But as the chart above shows, everyone else has been selling to the ECB for the past two years.

Checkmating the Troika

So, unless there is the political will to consolidate all of Europe’s debt under one roof, this problem lands squarely at the feet of the ECB, the Bundesbank and the farce that is German politics.

This puts the decision on the Troika – The ECB, The IMF and the European Commission — to bail them out directly or kick Italy out of the euro.  And that’s smart politics.  Make Brussels the bad guy.  And Salvini is already playing that tune perfectly.

If they were all smart, they would have the Lira ready to deploy if things go south.

Since Wolfgang Schauble stepped down as Finance Minister in Germany, there is no one ready to take his place as Mrs. Merkel’s attack dog in these negotiations.   I suspect part of the reason talks between Merkel and the Free Democrats broke down was because the FDP head, Christian Lidner, was in favor of kicking countries like Italy out of the euro-zone.

Merkel talks a tough game on this, but ultimately is about EU integration over everything else.  Schauble was as well.  And Varoufakis knew he had them dead to rights in 2015 but Tsipras folded a winning hand.

Schauble was the one who threatened euro expulsion on the Greeks which both he and Tsipras knew was unpopular.  It’s why Tsipras folded.  He wasn’t prepared to pay the political price to do what was in Greece’s best interest.

Does Salvini? Does Berlusconi?

The market at this point is handicapping that they don’t.  The headlines are all ablaze with all the Italian parties having backed off on Italeave. But is it real or just a vote-buying tactic?

For M5S it’s the latter.  The question is still out on Salvini and the Lega Norda.

If Germany tries to strong-arm Italy the same way that they strong-armed the Greeks, I don’t see it going the same way.  Ultimately, despite Berlusconi’s wrangling, a plurality of Italians are backing fundamentally Euroskeptic parties.

If Salvini is the real deal, he would use his alliance with Berlusconi to raise Lega Nord’s profile to 20%, then build a coalition with M5S after the votes are tallied, freezing out any chance of hijacking the process.

In the end, it won’t be hard for whoever is in power to make the argument in the face of a major banking and sovereign debt crisis.  Framing Germany as the bad guy will be easy and at that point the EU dives head first into its first real challenge to its authority.

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