Italy is too big to fail

A segment on the Dutch news program Nieuwsuur prompted this post.

Earlier today, I was looking at 10-year yields and noticed Italy jumping to over 3.7%. As I write this, the yield is 3.713%. And that’s up from a low of 1.633% in the past year. I believe it’s the bond vigilantes that are going to force the Italian government to cave on its tete-a-tete with Brussels. It’s only a question of timing.

But Italy is too big to fail. And I say that because an Italian politician in the Dutch TV segment made exactly those comments, prompting this post. Look at the clip here. What does that mean though, too big to fail?

I would say it means that Italy, as a G7 country, a founding EU member, and home to the largest government bond market in Europe, is simply too large to treat with the same level of contempt with which Brussels treated the Greeks. Even though I believe the Italian government will eventually cave, the reality is that an Italian debt default or exit from the euro would be catastrophic on a monumental scale. It would be a Lehman-style event in financial terms and would shatter the EU in political terms. So Italy does have some negotiating leverage.

But, what I think is happening is that the Italian government is simply making a political case within Italy, setting themselves up as a proper defender of the middle class so that they can benefit electorally. When they cave, they can say, “we tried to defend you but Brussels and the bond markets forced us to give ground. We’ll be back though. Please vote for us if you want someone to stand up for you in the future.”

Of course, there’s always the possibility that Italy will stand firm and risk default. So I wouldn’t completely discount that outcome.

But there’s one more thing from the Nieuwsuur video that made me think. One Five Star/Lega politician said Brussels was more concerned about the wishes of the ‘finance people’ than about the needs of the people. That’s a phrasing that Brussels will find difficult to work against.

You have grown men out of work, living off the pensions of their parents, without enough food to put on the table. That’s one of the middle-aged people the Dutch reporter met in the job center in Italy. So it’s not like we’re talking about lazy people or young people. We’re talking about people who should be in the prime of their working careers. And so the question is how do you support those people.

The EU continues to act as if Italy must follow the rules by keeping its budget below a threshold which will allow its debt to GDP ratio to shrink. And that’s even though it means Italy has to run a primary surplus and the deficit will be below the 3% Maastricht hurdle. That’s how big the ‘legacy’ debt burden in Italy is, especially with rising interest rates.

Frankly, that’s not going to work. Politically, Brussels is backing Italy into a corner. And the result is going to be skyrocketing euroscepticism in a country that’s too big to fail.