Wednesday, November 9, 2011

Ciao Italia

In terms of recent economic meltdowns of various nations, there are two important road signs that indicate that the markets believe a nation is insolvent. The first is when a nations ten year bond goes above 7%. The second is that their short term bonds.. most commonly the two year and five year bonds.. begin to pay more interest than the ten year bond does.. this is called an "inverted curve" or "flattened curve". Both of these events occured in March, 2010 for Greece, which caused {after a few tense weeks filled with deep denial} Greece to request a bailout from the IMF and EU on April 23rd, 2010.  Ireland's bond curve flattened in November 2010, which led her to announce a bailout agreement with the IMF/EU on November 29th.

The nations that have melted down so far are relatively small nations-- Greece's population is 10 million; Ireland's is only 4 million. Think of Greece as Arizona and Ireland as Kentucky. The Euro survived these meltdowns.

But yesterday it was Italy that saw it's yield flatten. This was followed by a utter meltdown which saw the yield on their ten year bond rise from 6.75% to 7.24%. For most of us, this isn't too drastic. But in the bond markets, given the amount of money Italy owes {over $2.5 trillion} this is a pretty drastic move, and at one point it reached 7.48% before calming down. Italy today reached the point where both Greece and Ireland cried uncle. Adding to the problem is Italy's Prime Minister, Berlusconi, who's gigantic pride is standing in the way of Italy recognizing the danger they're in. Certainly Berlusconi does'nt see it-- he made a comment yesterday that people were still buying coffee and clothes in Rome. He's also a crafty political survivor, though yesterday he agreed to step down at some undetermined date in the future. He's played this card before. So far, Italy has stubbornly resisted any changes to their overly generous welfare state, though yesterday they did pass a few measures. Tomorrow Italy is going to have a bond auction-- if they don't sell them all or they do but it's at a very high interest rate-- tomorrow could be really ugly. If it goes well, there will be a dead cat bounce rally.

The problem is that Italy is a very large country-- they have 60 million people. Thats essentially everything west of the Rockies, including those mountain states. As I write this, there is no possible way Europe alone will be able to rescue Italy. Today we reached the point where this has become a global banking problem. All of the things I've warned about over the life of this blog are beginning to happen.

Can Italy solve it's own problems ? Absolutely and immediately. If we woke up tomorrow morning and the Italian government agreed to live within its means and enacted a few labor reforms, this problem would be over by the time you finished the morning joe. But as of now, the political will isnt there-- and the Italian people don't want to tighten the belt. Nobody does.

What will happen ? IMHO, the gaping hole in Italy's ship is pretty much fatal if left alone. The EFSF {Europe's bailout fund} is not even close to being big enough. Ultimately someone needs to come up with at least a trillion, and probably two, to keep Italy's ship from sinking-- and soon. Here's a list of the choices--

1. ECB: Europe's Central Bank is capable of printing enough money to solve the problem. Germany, however, is not allowing this to happen because debasing the currency will lower the value of their savings-- and worse, it still does not solve the problem of nations living beyond their means.

2. US Fed: If there comes a moment when the markets are in a suicidal meltdown, I believe Ben Bernanke will step in with a cool trillion of freshly printed American money.

3. China: The Chinese have the money to bailout Italy and the rest of Europe's problem children. But many of China's powerful leaders wonder why China {who's people are still pretty poor} should bail out a relatively rich continent who has lived beyond their means and who seem incapable of changing this.

Ambrose Pritchard of the Telegraph today called for the US and China to lean on Germany and force them to allow the ECB to print it's way out of the mess. Paul Krugman has seconded the motion that the answer lies with the ECB and it's printing presses. China so far has done little except lecturing Europe and throwing a few pennies their way. Tim Geithner has also urged the Germans to relent and let the ECB print its way out.

Today there was an article that come out that might give us a clue as to where we're going with all of this: there are apparently some talks between Germany and France on setting up a framework under which some nations will be able to leave the Euro currency, though keeping them in the European Union.

Kowalski's Fearless Forecast: I believe that Bernanke's Fed and the ECB will attempt to print their problems away, taking care to recapitalize European banks. I look for this coordinated action to take place within weeks. Italy and Greece will be given the choice of accepting socially dangerous budget cuts or leaving the Euro. I believe both will accept the deal. Lets see if their societies hold together as they both enter deep Depressions and their social programs are sliced like a provolone. Soon enough, Portugal & Spain will share Greece's fate. 


  1. I am inclined to agree with you, Mr K. Ben to Germany: If you don't print, I will.... then kiss your jobs goodbye.
    Thanks for your insights, Sir.

  2. Been reading your blog for a while and this is spot on. At some point the Fed will step in to bail out Europe. The German courts have thrown a monkey wrench in things I believe. The Germans see themselves on the losing end of this deal even though they prospered the most from the Euro.

    I am watching for the united states of Europe or the Euro breaking up. The conturies that are in trouble are not going to change their welfare systems.

  3. The ECB bought the Italian Bonds on offer today, bringing down the 10 Year Yield to under 7%.

    So no panic this week. Not that changes any of the underlying facts, or the poor range of choices.

    It seems every one on Earth wants the ECB to "just buy it all", except Germany. We'll see how that plays out.

  4. Hi GAW ! Nothing on the ground has changed, and we've been down this road before with the ECB frantically buying to save a country from imploding. ECB attempts to save Greece, Ireland and Portugal were failures, though Spain has managed to slide under the radar. This isn't going away, and I'm thinking that within a few weeks the ECB will lose this battle as well. It's then that Ben and Super Mario will coordinate action.

  5. What I don't understand is why all this bond debt exists and nothing changes. It's just business as usual.

  6. "Soon enough, Portugal & Spain will share Greece's fate."

    Add Ireland to this list.

    Nice article. Thank you.
    Kansas here.