The Italian Opera Is Just Getting Started

Includes: FXE
by: Vinny Catalano

First the Greek tragedy; now the Italian opera.

As the global deleveraging crisis continues to wreck havoc on the eurozone, and interest rates for one of its largest economies hits record levels (see chart), it is advisable to understand the multiple dimensions of this financial and economic opera.

In his blog posting yesterday, Nobel Laureate Paul Krugman notes:

Italy is not a shadow bank; its debt has on average a roughly 7-year maturity, so high interest rates take time to filter into higher debt service. As a matter of arithmetic, this could go on for a while, maybe even a couple of years, without necessarily pushing the country into default.

However, Krugman also notes that:

Rates can go even higher; banks can come under pressure; and bank depositors can vote with their feet.

And therein lies the real trouble – a run on the bank, in this case, a sovereign. As the Financial Times noted recently:

The biggest US money market funds cut their exposure to European banks to another record low last month, amid continuing uncertainty over the fate of the region’s debt crisis.

As money flows away from risky areas and into safe havens like the US dollar-denominated assets, stress fractures in the global financial and economic fabric continue to break apart thereby producing a cascading effect upon all and an obsessive focus on who’s next.

Bottom line: This opera won't end until the fat lady sings. Unfortunately, I don't hear her even warming up.

And don’t think the Chinese are so dumb nor so economically secure (you can’t build ghost cities forever) that they will send boatloads of bailout cash to sinking ships around the world. Turandot falls in love only once.

But, hey, none of this really matters to the bottom-up boys and girls who are no doubt emboldened by the actions of their leader, Warren Buffett, who went on a spending spree in the third quarter.