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Italy — and Europe — in the Crosshairs

The Battle of Spain is over; the Battle of Italy has begun.

This morning we noted the first signs of falling confidence just hours after Europe’s announced $125 billion bailout of the Spanish banking system. By late this afternoon the news is all about fears that Italy will be next in line.

A Spanish collapse tests Europe; an Italian collapse could break it. That crash could come quickly. Despite the strengths of its economy — a solid manufacturing base, an inventive entrepreneurial class, famous brands and low budget deficits — things could get very ugly very fast in Italy. Italian households can be brutally realistic and unsentimental about saving their nest eggs. Nobody wants to be the last idiot left with money in an Italian bank if trouble really comes. Few Italians define ‘patriotism’ as being a sucker; look for the euros to come out of the banks very fast if rumors spread or panic grows.

But if an Italian crisis has become easy to imagine, a solution to the crisis is harder to see. Italy’s economy is so big, and its debt so large, that even the wealth of Germany and the other solvent states will be hard pressed to fund a bailout.

Worse, an Italian bailout will be hard to arrange — and it will be harder still to enforce the terms once the money is paid.

Remember this: the Greeks hoped that they could blackmail Europe with the threat of “mutually assured destruction.” They tried to play chicken, hoping that the EU would be so frightened by the specter of a Greek collapse that Greece could win substantially better terms by threatening to walk away.

But Greece is too small, and the rest of the Europeans had spent enough time preparing to weather the storm from a “Grexit” — a Greek exit from the eurozone. As a result, the Greek threats are sounding hollow and Greece is left without much room to maneuver.

Spain tried the same thing, and had much better luck. Spain is bigger, and the threat is more credible. Also, Spain did not have Greece’s long record of lies and broken commitments. Spain so far has had much more success in negotiating a bailout rather than accepting dictation.

Italy is bigger than Spain, and its diplomats are wily and good at brinkmanship. Italy is almost certain to play hardball if the skies continue to darken and a bailout begins to look needed. Italians are realists, and as they see it, the reality is that Germany will suffer as more or much from an Italian meltdown as Italy would. Don’t look for Italy to take less than full advantage of any assets it has.

Italy is also clever and inventive; look for Italy to figure out surprising ways to look as if it is extremely busy and intent on a reform process while very little actually happens. This is all the more likely because the Italian state probably can’t deliver on the reforms Germany and its allies want.  Orders can be given by ministers and effectively sabotaged by lifetime bureaucrats who know how to say ‘yes’ while doing ‘no’.

Even the threat of an Italian collapse will drive profound change and, likely, push Europe to the kind of decisive action (towards either a full fiscal union or a break up of the euro zone) that it has so far managed to avoid. Italy is one of the founding members of what grew into the European Union and the EU’s most important founding document in many ways is the 1957 Treaty of Rome. There is no way that Italy can be seen as part of Europe’s periphery. It is part of the core, and it is looking more and more as if Italy will present Europe with its greatest test and perhaps its defining moment.

The Battle of Italy is truly under way; the Battle of Europe comes next.

[Tuesday update: From the Financial Times: Spanish bonds fall to new euro-era lows and Italian bonds are also under pressure.

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  • Jacksonian Libertarian

    Maybe the Mayan’s are right and 2012 really is the end, at least for the European’s 😉

  • Mrs. Davis

    The solution is easy. Germany leaves the Euro. If the Netherlands and Austria wish to go, they can also.

  • Kenny

    “… the reality is that Germany will suffer as more or much from an Italian meltdown as Italy would.”

    Why do you say that? Do you have any proof?

    I personally don’t believe it. I wonder if the Germans do.

    • Walter Russell Mead

      @Kenny: German banks and other investors are deeply tied in to the Italian economy and would be hugely damaged both by the initial collapse and by the ensuing disturbances. Germany might recover more quickly, but Italy knows that Germany thinks that an Italian failure would be ruinously expensive for Germany and will therefore expect Germany to pony up to help avoid the catastrophe. Additionally, Italians blame German stupidity for many of the design errors in the euro and for the foolish investments and policy errors that have taken place since. They think that if Italy must pay a price, Germany too must pay for its many errors and stupidities. They don’t feel in any way morally intimidated by or inferior to the Germans. You can argue that they should, but Italians can be very good at shrugging such arguments away.

  • Luke Lea

    @ – “Even the threat of an Italian collapse will drive profound change and, likely, push Europe to the kind of decisive action (towards either a full fiscal union or a break up of the euro zone)”

    Hard to imagine a full fiscal union under these circumstances. A shotgun wedding?

  • Luke Lea

    Is there a way to gradually unwind the Euro? As in planned dissolution? I’d like to see somebody sketch out how it might look.

  • Anthony

    “The way out of this crisis seems very clear. First, there needs to be a program of direct recapitalization – via preferred nonvoting shares – of eurozone banks, in the periphery and the core, by the European Financial Stability Facility and its successor, the European Stability Mechanism.”

    “Second to avoid a run on eurozone banks…an EU-wide system of deposit insurance needs to be created.” For more related material on Quick Take subject matter see Nouriel Roubini and Niall Ferguson “The Current EU Bailout Approach Is A Disaster” (Financial Times Jun. 8, 2012).

  • Luke Lea

    @ Anthony – ““The way out of this crisis seems very clear. . .” I always love it when they start out that way. The answer is obvious, simple, clear, etc.. Obviously it’s not.

  • Brendan Doran

    Tech bubble crash is replaced by Housing/MBS Crash is replaced by Sovereign Debt crash – happening now. Each one an order of magnitude higher.

    Why wouldn’t they simply go out and bet crazy again? Maybe the next bubble will be derivatives based on fiat money – oh wait – how about pundit based securities..Pundit Weighted Notes (PWN) …?? Or perhaps make the Sky the Limit; Sky HIgh Treasuries (SHIT).

    Historian or perhaps Anthropologists sifting thru the layer of ash that was Civilization -see the end of the 2d Bronze Age – will marvel at our insane failure to take responsibility, demand it, and face the bitter pill. The real Titanic evacuation did not involve 1st Class stealing lifeboat seats. Our metaphor will be the Costa Concordia.

    Vada a Bordo, Cazzo!

  • Carlos Woelz

    Does anyone look at recent data? Italy is running a 4% of GDP primary SURPLUS. Nominal deficit is going to zeto IN THE MIDDLE OF A DEPRESSION.
    Are you guys blind? Italy is not the problem. US, Japan and UK are.

  • Lorenz Gude

    Grexit – no need to define it! I think Europe’s leadership is wedded to the EU concept and the populations of the various countries are still culturally distinct with the result that many, perhaps most countries would vote agains further fiscal or political union. The leadership has been able to ignore the way people feel but this is coming to an end. We shall see how strongly the Greeks reject the parties that want to go along with the Euro leadership in the second election. However there is another way people are voting and that is with their savings and that appears to be a much more effective way of unseating the Euro leadership than the ballot box.

  • Anthony

    @8, Luke Lea: Roubini and Ferguson presenting their idea on ways to address eurozone current dilemma – whether it is obvious and simple must be interpreted by others; but, both have insight into fundamentals.

  • Tom Richards

    Luke, you might like to take a look at the five shortlisted entries for the Wolfson Prize.

  • Tom

    Germany should leave the Euro, and allow the ECB to inflate the nominal debts down to a bearable level.

    An excellent first step would be for Germany, and Greece & PII(g)S too, to issue 0% 1 year Bearer Bonds, which they use to pay their bills (and stop borrowing euros). They could also accept such bonds as tax payments at 100%, while not requiring private business to accept them (tho not forbidding it; there would be some discount level for acceptance at most shops).

    The real problem is clear — too much gov’t spending of euros. eMark Bonds, or Drachma Bonds, allows staying in the euro while sort of paying in accordance with contracts.

    Those getting Bonds, instead of euros, get the cut. Such Bearer Bonds, which are paper notes just like “Federal Reserve Notes”, would become like an alternative dual currency for local domestic purposes, while the Euro remains the monetary legal tender anchor.
    Thus, the gov’t borrows from gov’t workers & recipients, to pay gov’t benefits.

    If any country already using bearer bonds wants to leave the euro, their Bearer Bonds can instantly be converted into a new currency by requiring that merchants accept them as payment.

  • K T Cat

    Walter, I love ya buddy, but you’re not taking this thing far enough out. A tighter European Union or its disintegration are both irrelevant to what’s really happening. At its core, this is unserviceable debt. Banding together doesn’t solve that and splitting apart doesn’t solve that.

    The Europeans will have to produce more than they consume. Whether they do that as the US of E or as separate nations is irrelevant. Whether they pay off their loans or not is irrelevant as well. If they do, they need to produce more than they consume. If they don’t, their banking system will crash and they’ll have to produce more than they consume to rebuild their wealth.

    The problem is much more basic than the politics suggest.

  • AlanC

    What seems to be missing from this analysis is the concept of a beneficial crisis. Most, if not all, of the EUrophiles and bureaucrats are looking at this as a major political opportunity NOT as an economic problem.

    The end goal is complete political integration with the technocratic elite getting to rule the EU and all the people in it. Look at what true fiscal integration entails. Once you turn all tax and bugetary authority over to the central government, along with all regulatory authority AND there are virutally no democratic processes to control the powerful you are left with the elite controlled world where the big bankers and politicians and their toadies run everything.

    A few toy parliments will be left around as a fig leaf but true control over everything will have been ceded.

    Good bye freedom.

  • Michael_B.

    I’ve long wanted US out of Europe. Might be best that we’ve stayed.

  • Ed Snyder

    What I don’t understand is, given the response to the Spanish bank bailout, how can the “Battle of Spain” be over? Unless you mean that it ended in a rout of the EU, that is.

  • cubanbob

    No rational Italian trusts the Italian State. Never has and never will.
    And with good historical reason. Italy will resist, there will be strikes by the unions, private sector and public. There will be riots as well. But if the Germans stay adamant and give the Italians a simple yes/no choice: Euro’s or Lira’s the Italians will always go for the Euro. They know what having a good portion of their savings and wealth wiped out by regular devaluations is like and that they won’t accept. Commenters always seem to ignore the reason why the Southern Europeans accepted the Euro in the first place, as a safety feature to preserve their wealth from constant devaluations. Just look at Greece, when the public is given a choice between Drachma’s and Euro’s every poll shows hands down they prefer keeping the Euro.

  • crypticguise

    The Euro and European Union is unraveling. Why is there any question about the inevitability of the fate of this ill-considered union of different National States.

    Germany can not save them all. It is only the Spanish Banks that were bailed out. Spain HAS NO MONEY. Greece HAS NO MONEY. The other profligate nations HAVE NO MONEY, and they can’t print Euros.

    Bite the bullet, folks.

  • RHD

    These bailouts may buy some time, but that’s about it. Funding structural deficits by issuing more euros (that’s all that is happening) increases the supply of euros as well as the debt burdens of the bailed-out entities, but doesn’t address any of the economic problems that resulted in the structural deficits in the first place. Of course, those debts must eventually be repaid. And when they are, the repayments extract real assets from the debtors and transfer them to the creditors — that’s the downside of deficit financing, which turns into the miracle of stimulus-in-reverse.

    The EU’s fix is even more perverse, in that the loans are being made by the ECB or EFSF to the central banks of Spain or Italy, which then lend/’invest’ the funds into their failing banks, who in turn use the funds to buy Spanish or Italian sovereign debt and record them as assets at full value on their balance sheets. At some point, probably sooner rather than later, that wonderful exercise in the free lunch will stop working, as it has in Greece and elsewhere in the EU periphery, when Spain or Italy run out of other people’s money.

    You have to sympathize with the Germans, Finns and Dutch, who clearly understand the madness they are being asked to finance. They know all too well that this exercise can’t possibly fix anything, and instead is quite likely to make the inevitable day of reckoning that much worse for them.

  • Dave

    Consider three options for the German government, with all German industries getting the same deal that BMW gets:

    #1: Keep “loaning” money to the PIIGS with no hope of repayment, just so they can keep buying BMWs.

    #2: Let the PIIGS go broke, buy all the unsold BMWs, and dump them in the North Sea.

    #3: Let the PIIGS go broke, and tell BMW to sell their cars to someone else.

    #2 costs less than #1 while maintaining the same level of German employment. But I doubt that even the most fanatical Keynesian would argue that #2 is better than #3.

  • Jim.

    “Nobody wants to be the last idiot left with money in an Italian bank if trouble really comes. Few Italians define ‘patriotism’ as being a sucker; look for the euros to come out of the banks very fast if rumors spread or panic grows.”

    Why do people assume that Germans define ‘patriotism’ as being a sucker?

    Sure, German banks made some dumb loans. Pay the price, lesson learned. If it’s dumb to loan out money you won’t be repaid, why is it brilliant to sign laws that make you give people money you won’t be repaid?

    If Europeans want a strong Europe, the way to do it is to be more like the Germans, plain and simple. If they don’t like that, they’re stuck with a weak Europe.

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