Yesterday, after Berlusconi announced plans to resign, I tweeted that tomorrow we'll wake up and Italy will still remain a low-growth, recession-prone, high-debt country -- nothing really has changed. Obviously the market could have cared less yesterday, as it went all giddy, but this morning it changed course 180 degrees. Sort of like a wild party Saturday night, and today is the hangover.
- Based on the size of the bailouts for Greece, Ireland and Portugal, a similar bailout for Italy would total around €1.4 trillion, estimated Gary Jenkins, head of fixed income at Evolution Securities.
- Economists have noted that Italy’s fiscal position is much stronger than the bailout countries. Italy’s deficit has remained low relative to other eurozone countries and it is running a primary budget surplus, meaning that it’s not creating new debt.
- But with a total debt load at around 120% of gross domestic product, Italy still faces a major challenge in rolling over its existing debt. Italy needs to roll over more than €300 billion of debt next year.
- “You can have a minimal debt/GDP ratio, but if you need to roll over any debt and nobody will lend to you and you cannot print your own money, then you are bust,” Jenkins said.
Italian yields jumped over 7%, and quickly are reaching the danger point.
- Investors dumped Italian government bonds, sending the yields well over the 7% level that forced Greece, Portugal and Ireland to seek international aid. The spike came after clearing firm LCH.Clearnet raised the margin, or collateral, that traders must deposit to trade Italian bonds across all maturities.
- “As the evidence of Greece, Ireland and Portugal has shown, once 7% is broken, the yield starts to rise exponentially. Every extra 1% on the yield structure for Italy’s debt profile costs an extra 3 billion euros ($4.1 billion) in service charges,” said Stephen Pope, managing director of Spotlight Ideas, a London consulting firm.
I've said for a few quarters now that the end game is the ECB throwing away all historical precedent (and their charter) just as the Federal Reserve was forced to do, and start their own version of quantitative easing by buying bonds in the market. If not, vigilantes will just go from one country to another and eventually get to Spain and France. Obviously in the U.S. that decision could be made essentially overnight, since the Fed already had the tools and authority to basically do whatever it wants. Not so much in Europe. Further, it will be a sea change in attitude because of the conservative German outlook on money. But I don't see any other way out of this mess other than eurobonds, and obviously storing junky bonds on the central bank's balance sheet is a far easier solution.
- Germany's "wise men" panel of economic advisers warned the European Central Bank it risks losing credibility by buying the bonds of heavily indebted eurozone states, and that monetary and fiscal policy are becoming worryingly blurred.
- The group, which advises the German government, said in a report published on Wednesday: "The bond buying program dismantles market discipline without establishing any political discipline in its place." In blurring monetary and fiscal policy, the report said, "the ECB is jeopardizing its credibility, because it is falling under the suspicion of monetizing sovereign indebtedness."
So we wait for the end game. As I have repeated many times, the irony in all this is that if every country had its own currency, we would not have any serious issues, other than a bunch of countries who spend like drunken sailors and then debase their currency to pay for it. While it leads to lower standards of living and ramps up inflation (got gold?) and simply shovels debt from one hand (government) to another (central bank), it's been working like a charm for the U.S. and Japan -- and even the U.K. nowadays.
I will again highlight to readers that the ultimate scary one is France. It has been seen as the twin brother of Germany, but is fiscal house is much more of a mess, and it has been given a free pass during this whole crisis. If Europe somehow thinks the ESFS bazooka can save Italy and Spain, it will finally relent when the vigilantes turn to France.
As for the market, it remains near impossible to trade when you rally hundreds of points on first a rumor, and then a face of a politician's fate, and then the very next morning lose all those points in an instant.