363. Memorandum From the Under Secretary of the Treasury for Monetary Affairs (Yeo) for the Economic Policy Board Executive Committee1


  • The Current Situation in Italy

Current Political Situation

The Socialists withdrew their support from Prime Minister Moro’s government on January 7. He handed in his resignation the same day but President Leone subsequently asked him to form a new government. The bargaining on a new government was complex and prolonged as the Socialists sought to protect their central role in the Italian political spectrum. Based on tacit acceptance by the Socialists of an economic austerity program, there is now to be a Christian Democratic minority government. It would govern until party congresses make a new government possible or elections are held either late this year or next. There are reports that the Socialists have agreed not to oppose a program involving a sales tax increase on non-essential goods, a heavy excess profits tax on industry, a freeze on upper income salaries and a series of modest technical measures which will increase the cost and reduce the availability of credit.

The outcome of this latest government crisis is the weakest government in many years. It results both from an institutional feebleness and from human frailties, both of which contribute to political party ineffectualness and corruption. The likelihood of continued weak government is made to order for the large, well-disciplined Italian Communist Party. Communist accession to power in Italy, or probably even participation in a coalition government, would have a negative impact on specific U.S. interests such as base rights. It could also profoundly change the character of the NATO alliance and the European Commu[Typeset Page 1114]nity and exert an unhealthy influence on the emerging political situations in Spain and Portugal. It is thus in our interest to do what we can to strengthen the democratic forces in Italy, particularly the Christian Democrats. In this regard, events in the economic sphere take on a critical importance. The success or failure of Christian Democratic economic policies is the principal determinant of the party’s political viability.

Economic Repercussions of Political Crisis

Despite a dramatic $8 billion improvement in its balance of payments in 1975, the year was not a good one for Italy. It experienced negative growth (for the first time since World War II), growing unemployment, and a high rate of inflation. The country is facing:

—the prospect of inflation rates higher than those of most of its trading partners (12% vs. about 8% for its partners);

—continued unemployment and underemployment, low growth (1 to 2%);

—an increasing budgetary deficit (12% of total national output) and

—pressure for large wage increases even though labor costs have increased at an average annual rate of 23% over the last three years.

Italy’s financial reserves have dwindled and its ability to borrow abroad sharply curtailed. A renewed deficit in the balance of payments was in prospect, partly because the expansionary internal policy adopted last fall to stimulate recovery was incompatible with the external policy of supporting the exchange rate.

Nevertheless, the Bank of Italy, at a cost of $2.1 billion, maintained the lira rate virtually unchanged for several months despite underlying economic conditions which, under our agreement at Rambouillet, would have suggested a gradual downward drift.

After the fall of the Moro Government on January 7, pressure on the lira mounted rapidly. The Bank of Italy recognized that any effort to peg the lira during the political crisis would require more financial resources than it had, but, having apparently lost a good deal of its traditional autonomy, did not withdraw from the exchange market until it could obtain the approval of the caretaker government. Thus, withdrawal did not come until January 20. Both the Bank and the government handled the situation badly initially, making “poor mouth” statements which, by encouraging adverse speculation, made the situation worse. Since January 20, the price of the lira in terms of the dollar dropped nearly 12 percent before recovering slightly and varied as much as 2½ percent in a single day.

The Bank of Italy now recognizes that heavy, extended intervention to maintain the exchange rate is impractical, and seems prepared to let the market continue to set the basic exchange rate even after an [Typeset Page 1115] economic program is developed in the context of the formation of a new government. It does not want to incur more debt to finance what would be likely to be ineffective intervention.

U.S. Assistance

The Italians have discussed the situation with us and with the International Monetary Fund. The IMF has outlined the conditions on which it would be prepared to extend further credit once the Italians develop a politically acceptable program. In addition, the Federal Reserve has allowed Italy to draw $250 million of very short-term credit under a long-standing swap arrangement. For the moment, there is little else to do other than watch the situation closely. How much, if any, further external financial support the Italians will seek when a government has been formed remains to be seen. A traditional, large-scale financial package to finance a defense of the exchange rate would not appear to be the answer. If sought by the Italians we might, however, consider supporting an IMF credit or announcement of some limited U.S. actions which would show political support for the Christian Democrats, and build confidence. For instance:

—A further credit of $250 million under the swap arrangements.

—Continued movement toward a large Export-Import Bank program to finance the development of Italian nuclear power plants.

If Italy develops serious balance of payments problems in the longer term, one avenue of multilateral support might be the Financial Support Fund of the OECD, now awaiting ratification. We have thought of this U.S.-initiated $25 billion fund as a source of contingency financing which could possibly never be used. In the case of a balance of payments crisis in a country like Italy, we would, however, be happy to have it in place. Activation of the Support Fund will require its authorization by Congress. A few key Congressmen, particularly Case, Church and Reuss, are still opposing passage. (We expected the Foreign Relations Committee to report out the bill authorizing U.S. participation February 3 but Church delayed action.) The possibilities in the Italian situation underline the need for firm Administration effort to get the Support Fund bill through quickly.

Edwin H. Yeo, III
  1. Summary: Yeo discussed the political and economic situation in Italy.

    Source: Ford Library, L. William Seidman Papers, Seidman Subject File, Box 122, Economic Policy Board Memoranda, 1/1–8/76. Confidential. Concurred in by Katz and Deputy Assistant Secretary of State for European Affairs L. Bruce Laingen. Yeo did not sign the memorandum. Seidman initialed the memorandum. From March 7 to 10, Simon, Yeo, and Seidman visited Rome for discussions with Italian officials on the Italian economic and political situation. Telegram 4037 from Rome, March 11, summarized their talks. (National Archives, RG 59, Central Foreign Policy Files, 1976) Memoranda of conversation recording their March 8 discussions with Baffi and with Colombo, as well as their March 9 discussion with Moro, are in Ford Library, L. William Seidman Papers, Foreign Trips File, Box 314, Rome, March 7–10, 1976 (1).