Borrowing costs are soaring across the eurozone as the Greek crisis morphs into something much more serious.
It’s fair to say that Europe’s leaders aren’t really impressing anyone with their crisis management skills.
About the only idea they agree on so far is that they should set up their own credit ratings agency. As Viviane Reding, European Justice Commissioner, tells The Times, this would “smash” the ‘cartel’ of US agencies who want to make life difficult for poor old Europe by pointing out how bust their economies are.
But while a pet ratings agency might be entertaining for the rest of us, Europe will have to do an awful lot more than simply pay someone else to pretend Greece is creditworthy.
Because now an economy that actually matters is in trouble.
Italy.
Italy is a hugely important economy
Italy’s farcical politics make it easy for outsiders to forget just how significant its economy is.
So forget talk of “bunga-bunga” parties. A crisis in the Italian financial system would be a big deal. Italy is the third-largest economy in the eurozone. It’s also the third-largest bond market in the world, behind the US and Japan.
It also has Europe’s second-highest debt-to-GDP ratio behind Greece, standing at 119% in 2010. And that’s the problem. Prime minister Silvio Berlusconi is meant to be pushing through a €40bn austerity plan to cut the country’s spending.
But voters are fed up. Times are already tough in Italy. So the last thing many in the government want is to anger them even more by making cuts. And the market has been unnerved by news that Berlusconi seems to have fallen out with his finance minister, Giulio Tremonti, the main architect of the austerity package. As the British are well aware from past experience, it’s never pretty when the guy in charge of the purse strings falls out with the guy who’s meant to be running the country.
One source told The Times: “The main element behind the turbulence is the fact that there’s political disagreement in Italy; they should get themselves in line and push through the necessary measures.”
What’s making things worse is the fact that the eurozone’s leaders are still going round in circles over what to do about Greece. As a result, the market has thrown its hands up in disgust and moved on to the next group of vulnerable countries.
As Toby Nangle at Baring Asset Management told the paper: “Since the crisis started, politicians have declared victory over it, and again we are back to square one.”
Greece, Ireland and Portugal are locked out of the market already. Now Spain and Italy are next in line. The rough line in the sand so far – the point of no return – is 7%. Spain’s 10-year borrowing costs rose above 6% yesterday, while Italy’s hit 5.7% and are still rising. You can keep an eye on these on our bond-watch charts https://www.moneyweek.com/investments/bonds.
Those are both eurozone-era records. (It is worth remembering that in the days before these countries were backed by the full faith and credit of Germany, their cost of borrowing was usually a lot higher).
What’s the endgame for Europe?
The fact that Italy is now in the firing line means some kind of endgame has to be approaching. There’s not a bail-out big enough to prop up Italy in the same way that the Greece situation has been dragged out over near-enough two years now.
I’d just like to point out: I don’t have it in for the euro. Europhiles seem to believe that eurosceptics have a vindictive hatred for the euro and can’t wait for it to fail.
Maybe that’s true of some. But I rather like the euro. It’s convenient. It feels a lot more convincing than a lot of the currencies it replaced. And if European countries want to be part of a single currency, that’s up to them. The British are out of it. It’s not for us to tell the rest of Europe which type of paper money they should be using.
The reason I’m sceptical about it boils down to hard facts. Currency unions fail unless they are backed by political and economic union. Europe currently isn’t. So just how close to full political union can Europe become before the voters decide they will go no further?
To draw a line under the crisis, I think we’d now need to see a plan for the eurozone to issue bonds jointly, as Wolfgang Munchau points out in the Financial Times. In other words, Greece would once again be able to borrow money using Germany’s credit card. The European Central Bank would also be able to do a more transparent version of quantitative easing: printing euros to buy eurozone bonds.
The alternative endgame of course, is a ‘disorderly default’ by one or more of the countries in trouble. It’s not possible to sketch out a step-by-step guide as to how this would happen. But for example, let’s say political collapse leads to one of the indebted countries turning around and telling its creditors they can sing for their money. The market panics first, then asks questions later. Borrowing costs shoot up across the eurozone, the weaker banks are driven to the wall, everyone’s looking for a bail-out again, but there’s no money left to fund it.
That’s what people mean when they’re comparing Greece to Lehman Brothers. It doesn’t have to happen that way. A solution exists, as long as everyone is prepared to accept the implications: much closer integration, and open fiscal transfers from taxpayers in one country to another (such transfers already happen of course. They’re just described as ‘grants’).
But look at how poorly the eurozone has managed the Greek crisis. If Greece is so unimportant, as the bulls keep trying to argue, then why hasn’t it already been dealt with? Why are we still writing about it 21 months after the problem was first uncovered?
If Greece – possibly the least systemically important economy in the eurozone – is that hard to deal with, how can these people ever hope to resolve a problem like Italy?
That’s why I think we’ll have to see a much scarier blow-up before this crisis is over. It’s just one of the reasons that we think the dollar is likely to make a comeback in the second half of this year. My colleague David Stevenson explains why in the latest issue of MoneyWeek magazine, out now: The dollar: will it rise from the dead? (If you’re not already a subscriber, subscribe to MoneyWeek magazine.)
It’s also a good reason to hang on to gold. Gold and the dollar often move in opposite directions to one another. But with fear over another financial crisis and potential currency collapse likely to build, having at least some of your wealth tucked away in gold is still a vital insurance policy. If you’re feeling more adventurous, you might also want to check out my colleague Dominic Frisby’s gold report, in which he tips some of his favourite gold mining stocks.
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