The Corner

Stai Calma

Open Europe makes a case for some calm about Italy here. Here’s an extract:

Italy has a mountain of economic and political problems, but there are far fewer short term triggers which can push it into a bailout in the near future. Its banks are solid – they have little external exposure to problem countries, a solid deposit base, large domestic sectors and decent liquidity following the ECB LTRO – and they did not face the same Spanish boom and bust.

 Italian households and corporations are not heavily indebted. There is less chance of this being a drag on spending in the economy as in other countries, while the state is unlikely to have to guarantee any private sector burdens anytime soon.

 Although the state is facing higher borrowing costs as the figures above suggest, it can handle this in the short term given the size of the economy. If it persisted then it would surely cause problems but with the horizon of a few months, it is likely to be manageable. The government can also rely on its domestic banking sector to buy up large amounts of its debt using liquidity from the ECB. This strengthens the dangerous sovereign-banking-loop and will store up problems in the long term but in the short term it would keep Italy out of a bailout. In many senses Italy is closer to Japan than some of the other eurozone economies – this may not seem like a favourable comparison but remember that despite its huge debt load Japan has managed to finance itself at low rates.

Fair points all, but what really counts at the moment is that an overwhelming percentage of Japan’s public debt is in in yen. That means that it can always repay its debts by turning on the printing presses. We could debate for how long Japan could keep doing that, but for now the point is that it can.  As all Italy’s borrowing is in a “foreign” currency (the euro), it does not have that luxury, and that makes all the difference.

I’ve linked a couple of times before to a paper by the economist Paul de Grauwe that discussed these issues within the specific context of the euro-zone (a monetary union without fiscal union), but one key takeaway is that such a system is unusually susceptible to panics. Panics are sometimes justified and sometimes not (in a later paper de Grauwe argues that investors have moved from not worrying enough about sovereign indebtedness to—in essence— worrying too much) but once the fear gets rolling most market participants don’t hang around long enough to find out. And that is the problem that Italy now faces.

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