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Jon Talton

Analysis and commentary on economic news, trends and issues, with an emphasis on Seattle and the Northwest.

November 9, 2011 at 10:00 AM

Italy moves euro crisis into much more dangerous phase

Italian Prime Minister Silvio Berlusconi said he would resign after parliament approved his austerity budget to “assure” investors. Investors are not assured, sending the yield on 10-year government bonds higher. It now sits at 7.40 percent. That might be manageable — Italy has a relatively small budget deficit and only needs to keep refinancing its high government debt — if the yield’s trajectory didn’t keep moving higher.

This is not Greece. Italy is the continent’s third-largest economy and if it goes down, so does the euro. As a story in this morning’s Seattle Times explained, the nation, unlike Greece, enjoys a real economy that makes things. Yet its not very productive, is stifled by archaic labor restrictions and suffers poor educational outcomes. The Great Recession brought all these weaknesses to the fore.

NYU economist Nouriel Roubini (“Dr. Doom”) has warned for years that Italy could be camel that breaks the back of the Eurozone. In addition to the political-monetary policy disconnect, Europe faces much slower growth ahead. He laid this out while appearing on a panel in Davos in 2006, prompting the Italian economy minister to shout, “Go back to Turkey!” (He was born in Istanbul, but spent 20 years in Italy). Such has been the denial, in Berlin and Paris, too.

As Peter Boone of the London School of Economics and MIT’s Simon Johnson wrote in a report last summer, “Europe’s financial system relies on moral hazard, i.e., a ‘no defaults’ policy, to attract the funding needed to roll over large amounts of short-term bank and sovereign debt. Now that politicians in creditor nations are calling for private sector burden sharing, investors are demanding higher interest rates to hold these debts. But higher rates may tip banks and nations toward bankruptcy.” And here we are. The cover of The Economist says it nicely.

Italy’s sovereign debt crisis endangers the continent’s highly integrated banking system in a way Greece never did. Greece is a little S&L compared to Italy’s Lehman Brothers. And if Europe’s banks start to freeze up, don’t for a minute think the contagion can be contained and not reach American institutions. So far, European leaders have been far behind in getting the crisis under control. Now it has spread into new, dangerous territory. Capital flight from Italy comes next. Then…

And Don’t Miss: Europe’s darkness at noon || Project Syndicate

Today’s Econ Haiku:

Whiskey won the West

If Costco had been around

Would have been sooner

Comments | More in Eurozone


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