Just as the Roman Empire supplanted Greece as the center of the ancient world, so too is the rapidly escalating Italian economic crisis pushing the Greek economic crisis to the side. Italy is a much larger economy—at more than $2 trillion in annual output, it is the eighth-largest economy in the world. And its sovereign debts dwarf those of Greece, at about $2.6 trillion versus a seemingly paltry $500 billion for Athens. Italy has the world’s third-largest bond market, and hence its troubles should have real systemic implications for us all.
But does it? I mean, does it really? The resounding answer in financeland is a screaming, unequivocal yes—much the same response that it gave to the Greek crisis, and to nameless crises before. Does Italy matter that much? Is it the tipping point that will plunge the world into the abyss that has been so feared and anticipated? We will know in due time, but honestly, Italy doesn’t matter—not nearly as much as it appears to.
That is certainly not how financial markets have been reacting, with yields on Italian debts spiking above 7 percent yesterday, in stark contrast to the sub-2 perecnt rate of U.S. Treasury bonds. Global equities had yet another spasmodic selloff, triggered in part by an obscure decision by a London clearing exchange to raise margin requirements on holders of Italian debt. And the real-world implications have been no less dramatic: having survived numerous scandals, sexual and financial, that made Bill Clinton look like a naïf, Italy’s astonishingly long-serving premier, Silvio Berlusconi, yesterday announced that he would relinquish control of the government.
That announcement did not satisfy the bond vigilantes, who took the resignation of Berlusconi as a cup-half-empty moment and promptly bid up the cost of Italian debt based on the fact that it will take some weeks for a new government to enact credible measures to address Italy’s structural issues. James Carville, the fast-talking Clinton adviser, once famously said that he’d like to be reincarnated as the bond market, because then he could “intimidate everybody.” Today, that market is most certainly intimidating the eurozone and by extension, the global financial system.
You could throw a dart in the past two days and hit a hundred commentaries declaring that we are now past the point of no return, that Italy may be too big to fail but is also too big to bail, and that Greece was always just a dry run for the debts that really matter in Europe, namely Italy. We are told—because it is true—that the Italians must refinance a bit more than $200 billion in the next year. We are also told that higher yields mean that a crisis is approaching. Really?
Let’s just take some basic math: at 4 percent rates, that new refinancing will cost $8 billion a year. At 7.5 percent (near where rates are now), that will cost $15 billion. The difference: $7 billion. And that is out of an economy greater than $2 trillion dollars. Over the next five years these extra costs might be as much as $100 billion, out of what should be about $10 trillion in total output. Translation: even at these elevated levels—a global crisis we are told—the extra expense of financing Italian debt is a grand total of 1 percent of overall Italian output.
The bond market and the politics of the eurozone, however, aren’t looking at it this way. Berlusconi simply is not a credible leader of economic reform, and insofar as the bond market has forced his exit, that may ultimately be good for Italy and for the world. But the notion that Italy is “the big one” and now we have reached the inflection point, that is just silly.
Italy needs perhaps $650 billion to allow it to avoid tapping public markets for the next three years. That is a decent sum, but more than within the ability of Italy, in conjunction with the eurozone, to obtain—and that is a worst cae. It is not a “game-ending” sum of money. It is not on par with the trillions of dollars of derivatives that companies such as AIG and Lehman had put into motion in 2008. It is a big number, but it is not that big a number, and when you look at actual Italian borrowing costs right now—that extra $15 billion cited above—the number becomes much smaller indeed.
So what’s the big deal? Once again, we are in the realm of psychology, markets, and sentiment. The bigger picture is that the expectation of endless, easy, and accelerating prosperity that infected both Europe and the United States was based on a false sense of destiny and demography. In Italy especially, a short work week, generous vacations and early retirement are seen as necessities, yet can only be maintained if there is more growth, more children, or more credit. That social contract is not tenable. But that reality is a far cry from the hysteria and cynicism of bond markets that we are on the verge of collapse.
The good news is that the departure of Berlusconi could be a tonic that awakens Italy from a stupor of lassitude and indifference. The bad news is that the financial world—which has an inordinate ability to bully the real world—remains wedded to hysterical assessments of stability versus collapse. Italy, Greece, and the eurozone are adjusting to the imperative of greater political union forced by the economic union. That is a hard adjustment. It is not the same as collapse.
You will hear no end to predictions of impending doom in the days ahead. A few economics firms have even announced that Italy has triggered a chain reaction that will likely lead to a complete financial meltdown just around Thanksgiving. I suppose we will know soon enough. But the alternate view is that Italy doesn’t matter per se. It is not about to default, and as large as it is, it is still one moving part among many.
What matters, and what has mattered all along, is the propensity of financial markets to go to extremes in ways that more than ever before generate the risk of global synchronous failure. That is alarming, yes, just as the risk of nuclear war was alarming—deeply so—in the middle decades of the 20thcentury. That risk never receded, but the fear and panic did.
We are now in a period of adjusting the reality of ever-present risk that the financial world, connected globally and electronically without circuit breakers, might fail. One day it is Greece, today it is Italy, and tomorrow it may be France or the United States—or Iran. We will over time learn to treat those risks with greater equanimity. For now, we at least need to stop and realize that Italy is a rich and vibrant society; a land of immense beauty and culture, with a fair number of viable and supremely successful industries. But is not the hinge of global prosperity; it matters, but not that much.