All too reminiscent of Groundhog Day, Greece’s never-ending sovereign debt crisis is again attracting attention. However, while markets and policymakers fret anew over the possibility that Greece might finally be forced out of the euro, Italy’s seeming political unraveling is attracting relatively little attention.
This is surprising considering that while the euro could very well survive a Greek exit, it certainly could not survive in anything like its present form were Italy to have a full-blown economic and financial crisis that forced it to default on its public debt mountain.
There is certainly reason for concern that Greece’s debt crisis might become acute by the summer of this year. After all, Greece has a large debt repayment falling due in July that it will not be able to make unless it comes to an agreement with the International Monetary Fund (IMF) and the country’s European creditors.
The prospects for reaching such an agreement are clouded by the fact that the IMF is conditioning its participation in any future Greek bailout program both on the Europeans agreeing to substantially write down their Greek debt claims and on the Greeks agreeing to become more serious about tax and pension system reform.
{mosads}Ahead of German parliamentary elections this summer, the German government is highly unlikely to agree to Greek debt forgiveness. Meanwhile, with his popularity plummeting and with Greece in a deep economic depression, Greek Prime Minister Alexis Tsipras is highly unlikely to agree to further painful economic medicine for his country. This will make it very difficult for the Europeans to keep the IMF involved in the Greek bailout program.
At the same time that Greece appears to be headed for another serious chapter in its ongoing debt crisis, Italy appears to be headed for early elections most likely this fall. Making such early elections all the more probable is the recent decision of former Italian Prime Minister Mateo Renzi to call for a leadership vote of his Democratic Party. Such a vote runs the real risk of causing a deep split in the ruling party, which might force early parliamentary elections to restore governability to the country.
Among the reasons that there should be greater concern about an Italian, rather than a Greek, economic crisis is that Italy has a very much larger economy than Greece. Being the third-largest economy in the eurozone, Italy’s economy is around 10 times the size of that of Greece.
Equally troubling is the fact that Italy has the world’s third-largest sovereign bond market with public debt of more than $2.5 trillion. Much of this debt is held by Europe’s shaky banking system, which heightens the risk that an Italian sovereign debt default could shake the global financial system to its core.
Were Italy to leave the euro, it would almost certainly default on its debt as the cost of Italian government borrowing after leaving the euro would rise to unsustainable levels.
Another reason to be more concerned about an Italian rather than a Greek crisis is that an Italian crisis would prove to be very difficult to resolve. This is not simply because, in the event of a crisis, Italy would require an outsized bailout package to save it that might put strains on even as robust an economy as Germany’s.
Rather, it is that, being largely political in nature, a future Italian crisis might not be as amenable to resolution, as was the case in Greece, by just throwing a lot of money at the problem.
Stuck within a euro straitjacket that has made it difficult for Italy to redress its economic imbalances, the country’s economic performance since 2008 has been abysmal. Indeed, Italian living standards today are around 10 percent below where they were 10 years ago. Meanwhile, Italy’s banking system has become highly troubled and its public sector debt as a share of gross domestic product (GDP) is now the second highest in the eurozone.
Little wonder, then, that the populist and anti-euro Five Star Movement has the wind in its sails and has now drawn equal in the polls to the ruling Democratic Party. It is also little wonder that almost all of Italy’s opposition parties would now like to see Italy out of the euro.
With contentious elections scheduled this year for the Netherlands, France and Germany, and with political storm clouds now gathering in Italy, one has to regret the Trump administration’s seemingly cavalier attitude toward Europe’s political and economic difficulties. One also has to lament the new administration’s seeming disdain for the multilateral lending institutions and for the need for international financial cooperation.
This all makes one have to hope that Europe’s many political and economic problems somehow go away and do not reveal how ill-prepared the world is to deal with another and more serious round of the European sovereign debt crisis.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.
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