Italy and Spain Must Pray for a Miracle

If Europe was on the brink of financial disaster last year, the threat is no less serious today. Fallout from Greece affected Portugal and Ireland last week, and is now engulfing Spain and Italy.

Italian and Spanish bonds are repeating the pattern seen in Greece, Portugal and Ireland before they spiraled into insolvency, and the virus is moving north. French banks alone have $472 billion of exposure to Italy and $175 billion to Spain, according to the Bank for International Settlements.

More loan packages solve nothing; this is not just a liquidity crisis. Europe needs Germany to recognize that this crisis is not a morality tale pitting the virtuous and thrifty against the feckless spendthrifts, but rather a North-South structural crisis caused by the inherent workings of monetary union.

Germany must either buy or guarantee Spanish and Italian debt, or accept that the EMU must break up with dire consequences for German foreign policy. And the ECB’s leadership is flawed; it clings to the idea that monetary policy can be separated from other emergency operations. Last week it raised interest rates again, kicking Spain in the teeth. Why? There is no inflation threat.

Italian GDP has not grown for a decade. The official forecast is 1.1% this year, 1.3% in 2012 and 1.5% in 2013, but outside analysts are gloomier.

The ‘elephant in the room’ is that Italy’s debt interest payments will explode if the average borrowing cost ratchets up 200 or 300 basis points. The apparently stable debt trajectory will take an entirely different shape. That is the fear now stalking markets.

A full-throttle global recovery would mitigate this; 5 years of easy money by the ECB to weaken the euro and stave off debt deflation would help, too. Without either, Italy and Spain must pray for a miracle.

To read Ambrose-Evans Pritchard article: Italy and Spain Must Pray for a Miracle