Rocking financial markets around the world, Italy’s spiraling debt and political crisis caused investors to bail out of stocks, running to safe havens like U.S. treasuries. Italy finds itself like Greece when it defaulted in 2015 on International Monetary Fund [IMF] debt, causing the Frankfurt-based European Central Bank [ICB] to write off $140 billion in Greek debt, a 50% discount on unpaid loans. Panic selling swept over U.S., European and Asian stock exchanges, fearing Italy could default on interest payments to the IMF. Fears of Italy leaving the Eurozone spooked investors, raising the prospects that the European Union’s third largest economy, behind Germany and France, could end ties to the Eurozone, if not the EU. Former IMF chief economist and now MIT economics professor Oliver Blanchard gave a bleak assessment of Italy’s financial mess, seeing no end in sight.
Italy’s creditors, whether at the IMF or global financial institutions, could raise interest rates or call in Italy’s national debt now at $2.8 trillion or 132% of Gross Domestic Product [GDP], now running at $1.97 trillion. When Greece defaulted on its debt in 2015, it was at 162% of GDP, leaving the economy in shambles. Blanchard said Italy creditors must “move carefully,” not making too many demands, fearing a Greece-like default. “I suspect in this case the EU will do whatever is needed to prevent contagion, so I’m not terribly worried about contagion,” said Blanchard.. “I’m very worried about Italy. Not worried about the rest of Europe. It will be tough, but the rest of Europe the rest of [euro] will be OK,” said Blanchard. Blanchard believes the ECB will do everything possible to make Italy whole, including supply enough cheap credit to get through the crisis.
EU leaders are most concerned about the populist Five Star Movement [MSS] and far-right Liga Party of Pablo Savona as Italy’s finance minister. Brussels worries about Savona who has the same anti-Eurzone propensities as Greek Prime Minister Alex Tsipras who played hardball with the EU before agreeing to billions in debt relief. Tsipras threatened to take Greece out of the Eurozone unless the ECP took on billions in Greek debt. While the ECB equivocated in 2015, German Chancellor Angela Merkel pressured ECB President Mario Draghi to bail out Greek debt. Now faced with a similar situation with Italy, Draghi won’t let Italy default for one second, regardless of the burden on Germany, France, Belgium and Netherlands. Italy went into crisis over the weekend when Italian President Sergio Mattarella blocked Savona from forming a coalition government.
Mattarella wants no part of Savona’s rebellious approach toward the EU, threatening to put Italy back on the Lira. Converting back to the Lira would cause widespread financial panic but, more importantly, cause Italy’s creditors to lose massive sums of cash, especially through devaluation. Greece found out the hard way that returning the old Drachma would have taken every Greek’s savings account and made it worthless. Eurozone countries know that staying on the Euro enables even weak economies to have stability from the Euro’s valuation. World currency traders prefer the Euro to many other global currencies, including the U.S. dollar, assigning it inflated value over the dollar, now 16 cents higher. Over the last five years, the Euro’s been valued at up to 40 cents higher than the dollar. Crises in the Eurozone with Greece and now Italy holds the Euro down in value.
Former IMF official Carlo Conttarelli has been asked by Mattarella to serve as interim prime minister, until a coalition government can pick an appropriate successor. With Italy’s political crisis, the Euro dropped 0.7% today to $1.15 per U.S. dollar, reflecting the added risk and global uncertainty. Italy’s stock market dropped 2.3% today, reflecting the political crisis. “The writing was on the wall,” Blanchard said. “When you have capital mobility and you give signals that you might not stay in the euro . . . then you expect investors to move, and I think that’s what we are seeing,” hinting that things will calm down soon. No one in the Eurozone believes that Germany will play the same kind of hardball with Italy that it played with Greece, giving Italy a better chance to resolve the crisis. ECB members don’t like Savona’s proposals to cut taxes, boost public spending and promote welfare benefits and pensions.
Italy’s debt crisis won’t run into the same roadblocks as Greece, where the ECB knew that Greece could never pay back the IMF of all its debt. Of all the Eurozone countries, Italy has the highest debt ratio at 132% of GDP. Italy’s formidable pension and welfare obligations make braking away from the Eurozone next to impossible. While Italians don’t like to owe the Frankfurt-based ECB, they also know that moving off the Euro would be catastrophic to Italians savings accounts. Frankfurt’s ECB expects Italy to commit to an austerity program, much like they did Greece in 2015. “No I’m not optimistic,” said Blanchard about a quick fix to the problem. At the same time, Blanchard knows whatever Savona’s promises, he’ll have to belt tighten or ruin his prospects of becoming Prime Minister. ECB wants assurances from Italy that it will meet it debt obligations or find new leadership.
