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Will Italy’s referendum become the next Brexit?

For an investment bank, nothing beats market volatility. Big up and down price fluctuations, or their expectation, create trading opportunities. Flat markets do not. Brexit created a gorgeous opportunity to make (and lose) fortunes; anyone who shorted the British pound came out on top. Italy could become the next trading opportunity as the European Union apparently trundles toward the cliff.

With the Brexit vote long gone, betting on the outcome of the Italian referendum has emerged as the next great geo-economic event. On Dec. 4 – the date disclosed this week by Italian Prime Minister Matteo Renzi – Italians will vote Yes or No to a suite of constitutional reforms that, if implemented, would simplify the country's horrendously complicated law-making process.

The vote sounds pretty dull until you consider the alleged implications of a No scenario – the latest polls say the referendum could go either way.

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It might see Mr. Renzi resign, triggering political paralysis, or outright chaos, that would allow the anti-establishment Five-Star Movement to snatch the next election and make good on its promise to hold a referendum on Italy's use of the euro. If Italy were to say arrivederci to the euro, the EU might be doomed. The exodus of both Britain and Italy would be fatal to the EU, no doubt about that.

No wonder the banks are getting their trading fingers limbered up. In a recent note, Société Générale said the referendum would "open up a new period of political stability." Nomura said the vote would amount to "testing Italy and the EU." Perhaps. As if to prove the point, the spread between Italian and Spanish 10-year sovereign bonds has been widening, with the Italian yield now about 0.30 percentage points higher than the Spanish yield.

Time for a reality check. This is not a Brexit-style vote, Mr. Renzi's resignation is not guaranteed even if the vote goes against him and a quick election is unlikely under any scenario. Investors dreading, or dreaming of, a fresh existential crisis that could rip Italy and the EU apart are indeed dreaming.

The Italian referendum lacks the clear elegance of Britain's June Brexit vote. Although voters will have to mark Yes or No, the question covers five reforms that, collectively, would amount to one of the greatest overhauls of the bureaucracy and the law-making process since the Second World War, all in the name of streamlining government and making it less prone to chronic instability (Italy has had 60 governments since the war).

The biggie is Senate reform. A Yes vote would end the Senate's perfectly equal powers with the Chamber of Deputies, Parliament's lower house. It would do so by shrinking the number of senators by two-thirds and stripping them of most of their legislative powers. The chamber would emerge as the dominant power, as the House of Commons is in Canada, and any party or coalition with a majority would be able to get its way.

While the polls are leaning somewhat toward the No side (Société Générale attaches a 55-per-cent probability to No) and the opposition parties are endorsing a No vote, the Yes side could still win. The vote is still more than two months away – an eon in politics – and the complicated phrasing of the question, oddly, may work in the Yes side's favour. Take this phrase: "Do you approve … the reduction of the number of members of Parliament [and] the restraint of the institutions' operating costs …"

For many Italians, that would be like asking if they want a free Ferrari. Almost all Italians complain about the size and cost of government and resent paying hefty taxes to subsidize its top-heavy status. The appeal of a smaller Parliament might be irresistible. The point being, the polls showing the No side slightly ahead may be wrong.

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Still, Mr. Renzi did himself no favours when, at the onset of the referendum campaign, he vowed to resign if the vote were to go against him. That in effect turned the referendum into a popularity contest, and his popularity has fallen since he became Prime Minister in 2014. But ever the slippery politician, he's retreating from his initial pledge, admitting that he has "made a mistake in personalizing the vote."

In other words, he may not resign if he loses the vote. If he hangs in, Italy might be spared an election until the scheduled end of Parliament in 2018, even if his refusal to resign would make the opposition parties livid with rage.

A Yes vote would give Mr. Renzi licence to do what he claims he wants to do, which is reform Italy's sclerotic economy and create employment. Of course, he could botch the job, sending Italy into a tailspin that could shatter the euro zone's third-largest economy and inflict another blow on the already ailing EU. But Italy could also use a streamlined Parliament to get its economic act together after two decades of zombie performance.

On the surface, betting on a No vote and subsequent political and economic upheaval seems the obvious bet, a "bigger threat than Brexit," as some investors and analysts have called the referendum. Forget it – there is no comparison. Britain is leaving the EU, Italy is not. The Italian referendum, while important, hardly amounts to an existential crisis for Italy or the EU even if it is lost, and it may not be lost. The real crisis would come in 2018, if the Italian economy falls apart and the anti-euro parties win the election. Then the doomsday traders would be happy.

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