Italian elections a disaster for the Euro?

That depends on whether the EU had been on a course for anything but disaster prior to this week’s elections in Italy, one of the flashpoints of the European debt crisis.  Mario Monti had tried to impose spending cuts and debt discipline in his government, and it looked as if the EU had headed off at least that particular crisis.  Thanks to a backlash to that austerity program and a populist ex-comedian, though, Monti got crushed in the election — and no one knows exactly what Italy will do now (via The Week):

Can the Italians be serious? That is likely to be the reaction of financial markets and the country’s euro zone partners as they ponder a disastrous election result, which could reignite the euro crisis. More than half of those who voted chose one of two comedians: Beppe Grillo, who really is a stand-up comic; and Silvio Berlusconi, who drove Italy to the edge of the abyss when he was last prime minister in 2011. Both are anti-euro populists.

This comedy could easily end in tragedy. The inconclusive result has echoes of last year’s first Greek election – except that Italy is bigger and more strategic. The country faces political paralysis, while its economy is shrinking and its debt is rising. The European Commission forecast last week that GDP would fall a further 1 percent this year after last’s year 2.2 percent drop. Debt, meanwhile, would reach 128 percent of GDP by the end of this year. …

The risk is not that Berlusconi or Grillo will be prime minister. It is rather than nobody will be able to form a stable government. The electorate split into three roughly equal groups: Berlusconi’s centre-right group, Grillo’s uncategorisable 5-Star Movement and the centre-left coalition led by Pier Luigi Bersani. The centrist coalition led by Mario Monti, the technocratic who saved Italy from Berlusconi’s antics but whose austerity policies were deeply unpopular, came a poor fourth.

But is this a setback, or just a demonstration that nothing much has changed?  Time’s Michael Schuman says it’s the latter:

Many of us warned that without major structural changes to strengthen the monetary union, intensive reforms within euro zone countries and an entirely different approach to tackling the crisis (not just austerity, austerity and more austerity), the debt crisis was impossible to resolve. Had Europe really escaped the jaws of death, without the dramatic reforms so many economists thought were necessary? In recent weeks I was wondering if my analysis had gone badly awry.

Ah, but then, there’s Italy. …

What we do know about the Italian election is that it showed how quickly the euro zone debt crisis can come back to life. Italy’s 10-year bond yields, a measure of how risky investors perceive Rome’s debt to be, began rising again after the messiness of the poll results became clear. Stocks tanked in the U.S. on the news. Italy’s FTSE MIB index was trading 4.99% lower at 15,552 at 11.30am EST Tuesday, when the market closed for the day. The market turmoil tells us how any one event in any of the euro zone’s troubled economies can resurrect jitters over the future of the monetary union.

The election also sends some even more worrying signals. Mario Monti, the outgoing prime minister, and his allies got trounced in the election, polling a dismal fourth. Monti, a former E.U. commissioner, was airlifted into the prime minister’s office in late 2011 to employ his technocratic skill at reforming the economy and averting an Italian meltdown. He managed that with some painful budget cutting and deregulation, and Monti was seen by many in Europe as one of the euro’s chief and most important defenders. His defeat sends a resounding message from Italian voters that they don’t much care for Monti’s euro-saving reforms, which helped topple Italy into a recession. Monti becomes the latest political casualty of the euro crisis. Meanwhile, that same disenchantment with reform is also building support for once-fringe parties. The new Five-Star Movement, which campaigned on an anti-austerity platform, was running a close third in the election results. What all this tells us is that the steps needed to put the euro on firmer ground are too politically unpopular to implement in today’s European democratic politics – a reality usually ignored by Europe’s leaders.

No matter what the politicians decide, it looks like they’ll have to run it by the comedian, although that won’t do them much good.  Beppe Grillo controls more than 160 seats in Italy’s Parliament, and has plans to force a new election if he can to win even more:

Grillo’s parliamentary list filled with political neophytes amassed enough votes in yesterday’s election to deny a majority to front-runner Pier Luigi Bersani and a comeback to three-time Premier Silvio Berlusconi. As his competitors seek to cobble together a make-shift alliance, the 64-year-old Grillo is keeping his distance and preparing for a new vote.

“They can’t hold us back any longer,” Grillo said late yesterday in a video posted to his website. “They might go on another seven or eight months and produce a disaster, but we will be watching and working to keep it under control.”

It could have been worse:

Grillo’s 5 Star Movement garnered the most votes of any single party in the Chamber of Deputies with 8.69 million of 35 million ballots cast, or 26 percent. The comic was denied the bonus seats handed out to the winning coalition because Bersani’s Democratic Party, which got 8.64 million votes, was boosted by smaller allies that brought its total to 10 million.

Whatever one thinks of Grillo’s background, he managed to tap into a deep vein of discontent among Italian voters on austerity measures and monetary policy necessary to keep the Euro afloat.  He could end up with another opportunity to gain traction with that message if Berlusconi, Bersani, and Monti can’t come up with some kind of combination that maintains a debt-management direction.  As it is, the prospects for economic stability seem to have worsened considerably, and the ripples of the election will find its way to the US economy soon enough.