In the end the central theme of most articles reporting on EU events, is that all roads end up leading back to Berlin, the powerhouse of Europe.
And who knows, perhaps Mario Draghi’s upcoming resignation and a possible wish to be the next Italian president is a sign that he wants to go back and save Italy from the wrath that Greece has suffered: Complete capitulation to Germany in exchange to economically stay afloat and keep from descending into social chaos as a result.
Italy is one of the world’s leading tourist destinations. The ruins of the Roman Empire, in particular, the Coliseum, Palatine Hill, the Pantheon and the Forum, are major attractions. New ruins are now being created to mark the political decay at work at the heart of Italy’s democracy and economic policymaking. These new ruins could well include the country’s central bank and parliament as well as the Eurozone as the stage is set for Europe’s next big economic debt crisis.
At the center of the brewing storm is the issue of confidence. When investors trust sovereign debtors, governments have access to credit markets. When investors lose confidence in a country’s ability to pay, they head for the door. The cost of borrowing goes up and at some point it hits a level where it becomes unaffordable to raise money.
Such a loss of confidence afflicted Cyprus, Ireland, Greece and Portugal between 2010 and 2012, shutting them out of public borrowing, creating the European debt crisis and forcing them to seek financial assistance from the European Union, European Central Bank and International Monetary Fund. Italy barely avoided that embarrassment.
The economy is in its third recession in six years, unemployment is 13.2 percent and youth unemployment is at 43 percent (according to national statistics office Istat). Growth prospects are not robust – a meager return of 0.2 percent real GDP expansion is set for 2015. Furthermore, Italy’s demographics are dismal. Designated by Moody’s Investor Service as one of the “super-gray” countries, the number of aging Italians dependent on a shrinking workforce is growing. This provides a considerable structural headwind to the economy.
Related to bad demographics is Italy’s 2,700 page labor code, which makes it almost impossible for companies to fire workers. Italian companies find themselves in an uncompetitive position as they cannot move rapidly to downsize businesses or adopt new strategies. It has also divided the work force into the older entrenched and often unionized working class and a younger work force that is forced to look to temporary jobs as one of the few outlets for employment. Many young and talented opt to leave. In its in its 2014-2015’s assessment of global competitiveness, the World Economic Forum ranked Italy 45th out of 144th, but its labor market rigidness was 136th, government efficiency at 143rd, and inability to make efficient use of its talent at 130th.
What is worse, much of that government debt is held by Italian banks. With an economy in the doldrums for years, Italian banks have increasingly bought government bonds. Italy’s central bank reported that as of October 2014 Italian banks increased their holdings of the country’s sovereign debt to a record high of €414 billion. Consequently, any crisis in government debt will quickly funnel into its banking system.
One last factor to consider is the ECB’s role. The central bank has pursued accommodative policies – more through suggestion and verbiage than quantitative easing practiced until recently by the U.S. central bank. In this sense, the ECB’s approach has continued to allow European sovereigns to borrow at cheap rates. Indeed, Italy’s sovereign debt measured by yields is more expensive than that of the United States. It can also be argued that the ECB’s accommodative policies have allowed the Italian political elite to go slow on economic reforms.
But ECB policy is heavily influenced by Germany, which has been opposed to quantitative easing and its representatives are said to be increasingly opposed to Draghi. Germany is resistant to ECB money-printing (monetary stimulus) and emphasizes that what is needed is more austerity. A Draghi departure would negatively impact market confidence in Italian sovereign debt. It could spark a major crisis, considering the confidence built up around him – rightfully or wrongfully.
An Italian sovereign debt crisis is the ultimate European nightmare scenario. Simply stated, Italy is too big to bail out. It would be difficult to ignore a default of part or all of the €2.3 trillion in Italian public sector debt. Italy is not Portugal or Greece; it is the Eurozone’s third largest economy. A major sovereign debt crisis potentially threatens the euro, the cohesiveness of the EU and global financial markets. It does not have to be this way. Italy’s political class has to move beyond its narrow short-term self-interests and think longer term or risk falling into a long-term economic suicide spiral. The rest of Europe, already threatened by Japan-style deflation, needs to push harder on reforms and the Germans must help maintain an accommodative ECB policy. The European experiment is speeding into 2015, with Italy at the wheel. Thus far seatbelts do not appear in evidence and no one knows if the brakes are still working.
Full article: The EU’s Day of Reckoning: Italy Is Too Big to Bail Out (The National Interest)