Monday, September 15, 2014

Italy The Achilles Heel of Europe

It is ironic and only fitting that Italy is shaped like a boot. Italy is loved and often the travel destination by many Americans and for good reason, it is downright charming. Way back in 2011 Nouriel Roubini warned that Italy needed to pursue an orderly restructuring of it's debt to avert a default in coming years. At the time he saw the ECB and Berlin could impose a depression on Rome if things were to continue as they were.  Almost everyone agrees that Italy’s public debt is unsustainable and needs an orderly restructuring to avert a default, but as usual in the Euro-zone no action is happening. In many ways Italy could be viewed as the Achilles heel of Europe.
Italy A European Debt Bomb Waiting To Explode

Italy is the third largest economy of the Euro-zone after Germany and France, unfortunately it holds the largest public debt totaling over 2 trillion euro. This debt has been growing at an astonishing pace, even in more recent times and particularly as a ratio to GDP. The fact that the GDP is contracting has exacerbated the problem. This is not sustainable and the country is held together only because of the direct intervention of the ECB which made over 102 billion euro of Italian bond purchases in 2011-2012 alone. This has continued since then and the sum has gotten much larger. Only through the LTRO can the finances of the Italian state be kept afloat.

The truth is that in all reality Italy went bankrupt in summer 2011. Back then we saw interest rates on the national debt spike going out of control and Italy lost access to the financial markets. At that time  the ECB and political authorities in Europe agreed to create around the country’s finances an artificial market to give the impression of stability and the appearance that Italy could work its way through its problems. Italy it appears is now forced to stay on this artificial support until the economic conditions improve and confidence is restored to where the country will have again access to real and normal credit markets. This most likely will never happen because not only is the country mired in debt it is also a mess politically.

Because of the sheer dimensions of Italy as an economy and as a debtor it dwarfs the problems posed by the PIGS that had received so much attention. We must remember to put this in proper prospective, all countries are not equal in size and the reason for their woes will vary. However, propping up an economy is not a long term fix and the ECB loaning money to banks to have them purchase government-issued bonds is a scheme and instrument that allows international investors to do an orderly withdrawal from Italy. The French and German's, whose share of this public debt is falling reflects the rise of Italian banks purchasing public debt.

We should not let this important signal go unnoticed, it goes in the opposite direction of an increased interdependency which would be expected from a monetary union preparing for a political union. It seems that many investors are actually systematically reducing their exposure in South Europe, possibly hoping that a future breakup of the common currency will have less harmful consequences if their involvement in the financial and economy destiny of those countries has been reduced and curtailed to the minimum. For Euro-sceptics, it is a signal that, once foreign investors withdraw, Italy will crumbly under the weight of its debt.

Footnote; Thanks for reading, your comments are encouraged. This post dovetails with several other recent writings. Related  articles may be found in my blog archive. Below is an article giving more background on the political happenings in the Euro-zone.

1 comment:

  1. I think you may be operating pursuant to an earlier economic paradigm.

    Today central banks print and loan to sovereign governments whatever is required to keep them afloat. This new model is used in all Western economies, and by the BOJ in the most extreme example.

    What's the injury? The expansion of unrepresentative government by the diversion of wealth to the state. If you look closely, the middle class savers are, as a consequence, being destroyed and, along with the loss of their capacity to save, the society loses new business starts and first time home buyers, while the retirees become a ward of the state.