Italy's budget crisis is a bigger threat to the EU than Brexit – you better start paying attention

The Italian banks and treasury are like two drunken giants propping each other up, inextricably linked by mutual weakness. When the crisis hits, they will go down together

“Fog in Channel, Continent cut off” is a headline that, so I always thought, appeared in the Yorkshire Post in about 1910. Apocryphal, actually, I now find. Still and all, it sums up the Anglo-centric mindset very well. Nowadays, the headline might better read: “Fog over Brexit, Britain cut off”.

Point being that the British, and especially the nation’s journalists, always believe that Europe – indeed, the whole world – revolves around Great Britain. Sometimes it might do, but increasingly seldom so. The truth today, had we the humility to admit it, is that the Italian budget crisis – as part of a wider economic calamity – is bigger than Brexit.

How so? Simple: because Italy has the capacity to blow up the European single currency, the euro. Britain, fairly obviously, can’t. Italy’s public finances, like its banking system, are a mess. Its economy is a mess. Maybe it is healthier than others (and may find itself soon enjoying some superior performance over post-Brexit Britain), but its problems are well known, deep seated and long standing. Aside from terrible demographics, sluggish growth and weak productivity, there are immediate and acute financial problems.

The Italian banks hold lots of Italian government debt that is in danger of devaluation, or default. The Italian government relies on the banks to lend it money to carry on. The Italian banks and treasury are like two drunken giants propping each other up, inextricably linked by mutual weakness. When the crisis hits, they will go down together.

The Italian government now wants to borrow more than European guidelines permit, and more than the European authorities feel comfortable with. “None of your business,” say the Italians, who increasingly loudly resent the interference of the EU Commission and the European Central Bank. “Oh yes it is,” say the EU officials, pointing out that the Italians have solemn commitments to honour to ensure the viability of the euro long term.

Thus far, the crisis has not turned critical because the European Central Bank has been willing (well not willing exactly, but obliged) to buy Italian bonds to help keep the country and its banking system going. That policy is being wound down, and is in any case unsustainable without a wider reform of the eurozone into a fiscal union, as President Macron proposes (and Chancellor Merkel rejects).

But still, regardless, Italy wishes to borrow and spend more cash. It might not be so bad if the money were to be targeted on investment in infrastructure projects; it is more likely to be in the form of cash handouts to Italian voters. The populist Five Star/Northern League coalition government is determined to be seen to do something tangible for its demanding supporters. It is even threatening to print its own euro banknotes, outside the control of the ECB, a fundamental breach of the European Monetary System rules. The EU and ECB says “no”. Hence the political crisis.

The Italians do not want to leave the EU or even the euro area; rather, they want to make it work their way. It is the opposite to the British, who just want to get out. The British option is easier to deal with for the EU. It is like the awkward member of the house share just finally moving out. The Italians are deciding to stay put, yet not doing their share of the washing and not chipping in to the house share budget. They sit in the corner and grumble about the housemates, or insult them, keeping them up at night with the noise. It is getting uncomfortable.

Sooner or later, Italy will provoke another eurozone crisis. The flaws in the single currency are real, and have not gone away since the Greek and other crises a few years ago. It requires its members to deflate when they become uncompetitive; they cannot devalue their own currencies because they no longer exist. Deflation – cutting public services and wages – is always painful, governments fall into paroxysms as they try to cope with conflicting domestic and international obligations. The Italians are trying simple defiance. It won’t satisfy investors.

Greece, crucially, was small enough to save. Italy is too big to fail, yet too big to save, also. As the third largest economy in the eurozone and with a vast national debt, it is beyond the means of the Germans to bail out, even assuming they wished to. Markets fear some sort of breakup of the eurozone, banks collapsing, political instability and much else spreading out from Italy towards the rest of “Club Med” and the EU in a wildfire of economic contagion. It could finish the euro; and that really does terrify Frankfurt, Brussels, Berlin and Paris – and financial players globally. Add the migrant crisis, though it is abating, and the march of neo-fascists grabbing chunks of seats in virtually every legislature, and you have a packed EU agenda that leaves little time for the stale, circular arguments of Brexit. They delegate those to Michel Barnier, and tell him to come back to them when something is agreed.

Contrast Brexit. Even under the nastiest of hard Brexits, the UK will make its own way in the world, and, with some adjustments to budgetary arrangements and voting rights, the EU will carry on pretty much as it did before (providing the Italians behave themselves). The EU will welcome new members to the east; conclude new trade deals with Africa and Asia; extend the single market to more service sectors; deepen defence and security co-iteration. It will be, more or less, business as usual for Jean-Claude Juncker and his mates. They care little for what the Sun says about them.

Yes, the Germans, Dutch and Finns will soon enough find themselves paying more in to the EU to cover the hole left by the British contributions, but, despite the moaning, they can manage that, one way or another. The UK and EU will trade, though both will lose out and the UK may find itself much the more damaged through loss of markets, investment and jobs. Britain’s exit will do the EU comparatively little harm, simply because the EU’s GDP is 10 times larger. A chaotic euro collapse would be far, far worse.

Indeed, many European federalists quietly welcome the departure of the sceptical, whingeing, obstructive, negative British, the better to pursue their integrationist project. It is the neo-fascistic Italians, and the rising tide of populism in arc From Sweden and Denmark, across Germany, Poland and Austria and down to the Czech Republic and Hungary that really freaks them out. Matteo Salvini and Marine Le Pen scare the hell out of them, not Boris Johnson and Nigel Farage. That’s why they have other, better, more urgent things to chew over at their summits.