Sunday, July 17, 2011

Dusting this off some

In case you hadn't noticed, Italy's been in the news a lot lately. Sure Prime Minister Berlusconi just lost one painful court decision (to the tune of €600 million) for corruption and is still on trial for orgies with underage prostitutes, but I guess that just isn't enough anymore to grab headlines in America anymore. So, we've stepped it up a notch. Lately smelly old Greece has been grabbing all the headlines, so Italy's thinking of really pulling out a showstopping number. They might go bust.

Bust would be bad. I have some friends and family who might be curious if it would be bad enough to chase me back home. Who knows. I'm optimistic, but really, who knows. If there's a default, several of the biggest Italian banks could go belly up- and there's no sign of there being anyone willing or able to bail them out. So think about the disaster the Lehman Bros. fold was, jam that in a country a fraction of the size of the US, and perhaps repeat the process several times. Well, that's the fear anyway.

So sit around the campfire kids, I'm going to tell the story about how Italy got here. No spin, just blow-by-blow. I think it's a fun story. Very Italian.

Ever since countries starting going bust around the EU (first Greece, then Ireland, then Portugal immediately followed by Greece again) people kept looking at Italy and waiting for a wobble that hadn't showed signs of coming yet. Italy has been living on thin ice for years. Their total debt is 120% of GDP. For reference- a 100% is considered really dangerous, and the US is at about 65% now [Edited- I originally wrote 80%. Sloppy fact checking department]. But Italy had been stable at that position for years. They showed no sign of being able to grow their way out of trouble, but whenever necessary, they tightened their belts.

Then the Italian government picked a really bad time to wobble, as Greece looked to be careening to a 3rd bailout- or worse. Berlusconi's 15-year long grip on Italy was weakening. He got pounded in 2 straight elections. So he and his coalition buddies start grumbling about tax cuts- something the market would absolutely not forgive if it expanded debt. But it was all political postureing. Despite the fact that both parties in the 2-party majority here would have wanted tax cuts, they were never going to get them. How? Finance Minister Giulio Tremonti is practically a 1-man show with the budget. Then Tremonti got sucked into Italy's latest corruption scandal (*sigh*). The markets started to freak.

Here's the problem with having a 120% debt. It's like having huge credit card bills and barely squeaking by with just covering the interest. Imagine the bank that issued the credit card suddenly declares it refuses to extend your credit and needs all the money you owe now. That would never happen with a credit card. If you can't pay the interest on your debt anymore the banks shrugs it off without noticing. If a country can't pay its interest payments, banks go bust. The banks have an incentive to understand sooner rather than later when a country is going bust long before it happens so they're not the ones left holding the hot potato. Soon everyone gets nervous, and starts avoiding the debt. The only offer of loans the state gets come at higher prices to offset the higher risk of default. So higher prices become higher debt, which lead to higher prices and... default!

The only way out of that spiral is to prove your a safe bet- i.e. you suck up huge cuts in the hope the simple act of austerity will soon lower prices to where they were before. Italy was already working on a belt-tightening measure when everything broke: it was ultimately considered half-convincing. Basically the idea of the austerity was appreciated, but not so much the fact that most all the cuts kick in during 2013, conveniently delayed until after scheduled elections. So their borrowing costs when down a smidge, but are still well above where they were a few months ago. As if the markets have said "No really, this is your last warning now!"

So my hopes: we squeak by here another year or two. Berlusconi will be gone after 2013, that much is sure, but all the rest is up in the air. Maybe we'll get lucky and get some competent management here. Hmm, why do I feel obligated to make some light-hearted joke intimating my doubt here?


  1. Good write up. So much of these debt and bail out discussions are so heavily politicized that it can be hard to figure out what's really happening and at stake.

    I got a few questions in case you feel like doing another on the topic:

    1. How did the debt develop in the first place? Was too much social spending the problem?

    2. Are austerity cuts really the answer? On the one hand they curb spending, but on the other hand they take money out of the hands of the consumers who drive demand which feeds the rest of the economy.

    3. What will the practical effects be?

    4. When is the world going to declare another debt Jubilee already and tell the bankers to get lost? :)

  2. I was really hoping you'd chime in with some thoughts for me to respond to! No time to do a proper answer here, but this post did somewhat beg another that describes the "where do we go from here?"
    Sneak preview though to question 2: Nobody really knows. Austerity quite possibly made things even worse in Greece as the bottom fell out of the economy. But doing nothing is hardly an option either...