2.6 Trillion Reasons to Worry

07/11/2011 5:22 pm EST


Jim Jubak

Founder and Editor, JubakPicks.com

“If I fall, then Italy falls. If Italy falls, then so falls the euro. It is a chain,” Italian finance minister Giulio Tremonti said over the weekend.

The grandiosity of Tremonti’s rhetoric aside, global financial markets have bought into his logic today:

  • The French CAC stock index closed down 2.7%.
  • The German DAX index was down 2.33%.
  • And the euro was down 1.74%, to $1.4016.

Yields on Italy’s ten-year bonds were at 5.68%, a nine-year high. That puts Italy perilously close to the 7% threshold that triggered bailout rescue requests from Greece, Ireland, and Portugal.

Why is Italy in crisis today? And why is what happens with Italy so important to the euro?

Italy makes so many bondholders nervous because it is the world’s third biggest debtor after the US and Japan, with $2.6 trillion in government bonds outstanding. The country will run a budget deficit again this year that will push debt to 120% of GDP.

Tremonti has introduced a $57 billion austerity package designed to eliminate the budget deficit by 2014. The package is vague on crucial details, and depends on other new legislation that won’t necessarily get past parliament. But it is the only game in Rome.

But Tremonti has been cut off at the knees by Prime Minister Silvio Berlusconi. The package has been approved by the full cabinet, but Berlusconi has criticized the package as too severe.

Berlusconi has also endangered its chances of passing—and raised odds that Tremonti will resign—by saying that he wants to add a clause to the package...one that would allow his media company, Fininvest, to delay paying an award of about $800 million, after a court found that a Fininvest lawyer had bribed a judge in the battle to control publisher Mondadori.

This has weakened a coalition government where:

  • the prime minister (Signor Berlusconi) faces three concurrent trials for tax fraud, corruption, and sex with an underage prostitute;
  • the agriculture minister is to stand trial on allegations of links to the Mafia;
  • five members of parliament in Berlusconi’s party have been served arrest warrants on charges of corruption. Tremonti’s political advisor, Marco Milanese, is one of the five accused.

Italy’s actual financial problem wouldn’t be enough to rattle the financial markets without this political backdrop. Italy’s debt equals an estimated 120% of its GDP, but its current budget deficit is only 4.6% of GDP. That compares to 9.2% for Spain and 7% for France.

On the other hand, Italy’s economy grew by just 1% in the first quarter.

The fear, though, is that Italy’s political chaos will prevent the country from doing anything to address its debt and budget problems. And that if Italy goes, the pressure on Spain will become impossible to resist.

Italy alone may be too big to save. Italy plus Spain certainly is.

Full disclosure: I don’t own shares of any of the companies mentioned in this column in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund (JUBAX), may or may not now own positions in any stock mentioned in this column. For a full list of the stocks in the fund as of the end of March, see the fund’s portfolio here.

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