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November 8, 2011
The euro's sovereign debt--really government debt--- crisis has different effects. With respect to Italy the key problem is not the government borrowing to cover current spending as with Greece. The Italian economy is not a shipwreck. Italy is indebted, but it isn’t insolvent.
The problems lies with the bond markets, which are essentially the trade in government debts and Italy's is among the largest at around €1.9tn. The yield on the price of government Italian bonds has risen sharply – this is equivalent to the interest rate charged to the Italian government to borrow money. The more the yield rises , the more likely Italy won't be able to refinance its loans and the more likely a default is.
The yield on Italy's ten year bonds has hit a record high of 6.74% despite intervention in the markets by the European Central Bank (ECB ) to buy the bonds. 7% the point at which the IMF moved in to bail out Ireland. hit a record high of 6.74%. German 10-year bonds now yield 1.82 percent. The gap is a reflection of the extra risk of holding Italian bonds.
Steve Bell
This intense pressure from the bond market then causes political upheaval and crisis. Something has to give because Italy is too big to rescue. Unlike Ireland, Portugal, Greece the European authorities will not rescue Italy.
The Italian government debt is almost 120 percent of GDP, behind only Greece within the euro area, and the Europeans (France, Germany and the European Central Bank) are pushing Italy to undertake structural reform. This rationale for this fiscal austerity is that this budget tightening will restore the confidence of financial markets.
But the Italian government has been unable to make these reforms. The Berlusconi government is weak, and in all likelihood, it will collapse from being unable to push through the austerity measures being demanded. This fall will happen sooner than latter.
Update
Silvio Berlusconi goes, but the right stays in power. The country's debts threaten to take down stock markets around the world, as the yield, or effective interest rate, on 10-year Italian bonds reached a record 7.5% on Wednesday. The surge in Italian bond yields was eventually capped by the European Central Bank (ECB), but it has limited fire power to act as a lender of last resort to bring interest rates down to pre-crisis levels.
This indicates that the removal of Berlusconi as Italy's prime minister provides little by way of solution. The bond markets are calling for the implementation of structural reform it has has promised to undertake. The passage of the legislation has become a litmus test of Italy's credibility in the markets.
The medicine is the same as it was for Greece. The formula is to force budget tightening on an economy that is already shrinking or on the edge of recession. This shrinks the economy further, causing government revenue to fall and making still further tightening necessary to meet the target budget deficit. The government's borrowing costs rise because markets see where this is going. This makes it even more difficult to meet the targets, and the whole mess can spiral out of control.
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There is something fundamentally rotten in the global finance economy---we have the spectacle of the big banks betting against the success of their clients via instruments such as credit default swaps.
The rottenness is the vulture capitalist gamblers at the heart of the global finance industry