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We really need to pay attention to what is going on in Europe these days.  This could spread like wildfire and have a big impact on the world and U.S. economy, and effect the 2012 elections.

In the last week, it looks like 2 European governments have fallen.  The bond vigilanties that Krugman makes fun of, are beating at the doors of Greece and Italy.  This is not good news for the entire world.

There's probably 2 ways this can end up, and neither is going to be very good for anyone.  We need to pay attention, and be prepared.  

First, here's some news reports:

Italy at breaking point, Merkel calls for "new Europe"

Italian 10-year bond yields shot above the 7 percent level that is widely deemed unsustainable, reflecting investors' concerns that they may not get their money back and prompting German Chancellor Angela Merkel to issue a call to arms.

Merkel said Europe's plight was now so "unpleasant" that deep structural reforms were needed quickly, warning the rest of the world would not wait. "That will mean more Europe, not less Europe," she told a conference in Berlin.

Merkel calls for new Europe

Silvio Berlusconi, Italy's embattled premier, will resign shortly afterward, Napolitano's office said in a written statement.

Either a new government will be formed, the statement said, or elections will be called soon after the long-awaited reforms are approved.

The head of the International Monetary Fund, meanwhile, painted a stark picture of the challenges facing the world's economic stability as attention focused on Italy.
"The global economy has entered a dangerous and uncertain phase," Christine Lagarde said in remarks prepared for delivery at the International Finance Forum in Beijing.

"If we do not act, and act together, we could enter a downward spiral of uncertainty, financial instability and a collapse in global demand. Ultimately, we could face a lost decade of low growth and high unemployment," she said.

Italy to adopt reforms

And from Krugman:

This is the way the euro ends.

Not with a bang but with bunga-bunga.

Seriously, with Italian 10-years now well above 7 percent, we’re now in territory where all the vicious circles get into gear — and European leaders seem like deer caught in the headlights. And as Martin Wolf says today, the unthinkable — a euro breakup — has become all too thinkable:

This is the way the Euro ends

This is serious stuff folks.  The issues we think might be big in next years election, might get tossed out the window if this problem isn't solved quickly.

I believe there are 2 ways the Italy problem might conclude.

1) Default:
Hang on to your butts if this happens.  Most people reading this would become the new American poor, and it would be a 1930's type of poverty.  Here's how we get there.  Italy defaults on it's debt, that debt is held by a lot of European banks, many banks throughout Europe begin defaulting on their debts and start to fail, there's a run on European banks and the banking system starts to collapse, which triggers a gazillion credit default swaps that were issued by, you guessed it, American banks.  In the meantime, interest rates in France start rocketing and France becomes the new Italy.

This scenario leads to a world wide depression worse than the 30's, a truly unthinkable event.

2) The ECB steps up and starts printing Euro's to inflate away the debt:
This devalues the Euro a lot, which makes everything made in Europe cheaper and everything made in the rest of the world, including the U.S., more expensive.  The U.S. then starts to see it's exports start to drop, unemployment starts rising, GDP starts dropping, the deficit starts skyrocketing, and the Republicans sweep the 2012 elections claiming that we should have implemented austerity a year ago.

The only option for the U.S. will be for Bernanke to crank up the printing presses and devalue the dollar so we can raise our exports.

Ok, this could get very ugly in a hurry and it's going to throw next years elections into complete turmoil.  So I suggest we keep an eye on what's happening in Europe, and hope and pray to whatever deity you follow, that they can quickly get this under control before it gets completely out of hand.

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Comment Preferences

  •  Ok, as much as I love Krugman (2+ / 0-)
    Recommended by:
    FG, historys mysteries

    I don't see this scenario happening.  And I live in Italy off an Italian salary from my husband's Italian government job, so let's say I have skin in the game.  

    The first thing Mario Draghi did a few days ago upon assuming the presidency of the central bank was to cut interest rates.  He apparently did this in defiance of German interests.  Like Krugman, I think many in Europe are beginning to think Trichet was a total idiot.  

    Consider also that while Italian politics are fractious, all of the opposition--both center-left and center-right--are united on getting a solution for stability on track as soon as possible.  Gianfranco Fini, vice president of parliament (kind of like our Speaker of the House), has said that a vote on the law for stability could come even before Sunday.  Nobody except for those in Berlusconi's party is calling for immediate elections.  Everybody understands what is at stake.  

    So while I agree with you that the US should keep its eyes on what's happening here, I don't think the situation is as dire as you make it out to be, despite panic in the markets, speculation, and the damn spread between the BTP-Bund.  

    •  actually its worse then you think (1+ / 0-)
      Recommended by:

      its pasted the point of no return. Mathematically Italy will have to default. There is no two ways about it.

      Of course first since there is little private debt, the banksters and the world 1% will suck Italians dry first.

      But be assured, it's worse than you think.

      The house of cards is falling.

      Bad is never good until worse happens

      by dark daze on Wed Nov 09, 2011 at 10:33:39 AM PST

      [ Parent ]

      •  I have seen nobody besides you (0+ / 0-)

        publish such a dire account.  What are you basing your math on?  Seriously, I'd like to know.

        •  Merkel is talking of cutting you loose (1+ / 0-)
          Recommended by:
          dark daze


          I'm sorry, but how serious do you need it to get?  Merkel knows Italy is toast and is going to drag Germany down with it.  Italy's growth rate can't support a 7% interest rate on it's debt.

          •  Nope--reread the article (0+ / 0-)

            They talked about cutting Greece loose, not Italy.  

            Italy isn't toast.  This country always has a few surprises up its sleeve.  Watch.  I'm as critical of this country as you can be, but I don't buy the apocalyptic predictions.  

            •  Why did she wait until the 7% on Italian bonds? (1+ / 0-)
              Recommended by:
              dark daze

              Greece has been a big problem for nearly a year.  Greece can actually be fixed, but unless the ECB comes in and bails Italy out, Italy will default and drag the entire world with it.

              Italy is too big to fail, and for yours and my sake, I hope the ECB jumps in to stop this from happening.

            •  no actually (1+ / 0-)
              Recommended by:

              they are talking about abandoning Italy.

              and here is hwy they are past the point of no return..


              Bad is never good until worse happens

              by dark daze on Wed Nov 09, 2011 at 11:09:16 AM PST

              [ Parent ]

              •  From the article: (0+ / 0-)

                "At a G20 summit in Cannes last week, Merkel and French President Nicolas Sarkozy conceded for the first time that Greece might have to leave the 17-nation currency bloc at some point."


                "Former German foreign minister Joschka Fischer, a longtime supporter of European integration, said in a newspaper interview on Wednesday the 27-nation EU was too unwieldy and that it was time think about forming a smaller group capable of pursuing needed reforms."

                OK?  So tell me where it says they're talking about Italy.  They only said that they're "watching developments in Italy with great interest."

                Italy is the world's 7th biggest economy.  They can make fun of the government, they can even send in EU observers to confirm reforms, but they can't cut Italy loose.  

    •  Thanks for your input. Do you think austerity (1+ / 0-)
      Recommended by:

      will work?  It hasn't worked in Ireland or Greece.  In fact, I think Krugman is right when he says it will make things worse.  And it doesn't even address the immediate problem Italy will have in rolling over it's debt.

      Merkel is even talking about breaking up the Union into 2 parts.  I'm not sure it gets more serious than that.

      Italy simply can't survive with interest rates over 6% much less 7%.  

      I can only wish you the very best in what is about to be some very difficult times.

      •  No, they won't vote for austerity. (1+ / 0-)
        Recommended by:
        historys mysteries

        Italy's main problem is economic stagnation, stemming largely from little mobility in the work force.  In the short term, they're probably going to punish unions by creating some measures that make work contracts even more flexible.  

        They may even make some unpopular reforms to pensions, such as attempting again to raise the retirement age.  It's highly problematic and complex, considering that Italy's population is already quite old and at 0% pop growth.  

        They can't squeeze the various ministries much more than they have already without closing public schools, universities, embassies and consulates.  There's not much more to take there.

        Regarding Merkel, all I have to say is SCREW GERMANY.  Seriously, nothing they've done has been good for the countries directly involved in the current crisis.  Shit, Greece is already beginning to look like Argentina during the worst part of its crisis.  

        What pisses me off are these mysterious speculators who are fucking with the Italian market.  I'll admit to not understanding much about macroeconomics, but all of this panic seems linked to a limited set of circumstances which are in the process of changing.  You can't expect the Italian government to execute a major financial overhaul in 24 hours.  They're going to need more time to get this shit together.  Berlusconi has had almost 17 years to screw this country up.  It's going to take a few minutes to get the house in order.

    •  Yeah, Trichet was an idiot. Good thing at least (0+ / 0-)

      some people recognize that.

  •  Default is NOT the end of the world. Argentina did (1+ / 0-)
    Recommended by:

    that in the early 2000's. The impact to the rest of the world was negligible. People like to imagine a default as a government completely refusing to pay a single dime to creditors. Actually that's not likely. What will most likely happen is something similar to Argentina. They will:
    1. pay out less interest
    2. reschedule to stretch out the repayment schedule
    3. convert the debt to the new currency, instead of the original currency which was pegged to the US dollar (and in Italy's case- pegged to the EU because it is the EU)

    So in other words, the bond holders will have to take a hair cut. But it won't be a total and complete loss like a lot of nightmare scenerios that people are bandying about.

    We've got to stop this meme that countries must never, ever default on their debts.

    •  Italy is a LOT different than Argentina or Iceland (0+ / 0-)

      Italy can't default while it's in the Eurozone.  And Argentina didn't owe nearly the debt that Italy does, and the rest of the world was growing enough so Argentina could export it's way out of some of it's problems.

      A default by Italy will drag down a lot of European banks in Germany and France which will then hit American banks, and we're back in 2008 only with problem being MUCH worse.

      •  Why can't Italy or any EU country default? (0+ / 0-)

        That talking point is simply not true. Any EU country can default. The people who will be hurt will be the German and french banks who hold a lot of the debt.

        Just bail out a few bank depositors. That's cheaper than bailing out a country.

        As to your contagion 'dominoes theory' - well, Iceland's banks defaulted on their obligations. There is no domino effect on the US.

        •  You are right, Italy can technically default (0+ / 0-)

          But as long at they're part of the Eurozone and don't have their own currency, it would be a complete disaster for them.  Once they leave the Eurozone and have their own currency, they can depreciate their currency and export their way out of the mess.  That would work if it wouldn't create a disaster for France and Gemany and the rest of the world.

        •  The French and German banks hold (0+ / 0-)

          about 600 billion Euros of Italian debt I read.

          They can handle a Greek default, but they can't take a 600 billion Euro hit.

        •  Notes (0+ / 0-)

          Iceland's banks defaulted, although even still, they're going to be paying back their obligations (their assets, bolstered by tons of Icelandic government investment (using loans from, among others, the IMF), are now worth enough to cover their  obligations, and the Icelandic supreme court ruled last week that they have to cover them (which had long been expected).

          But ignoring all that, we're talking private debt, not public debt.  And beyond that, Iceland has a small enough economy that the world can effectively ignore it.  It's only 320,000 people.

  •  One possible solution is to allow (0+ / 0-)

    countries to borrow from the ECB to pay off maturing debt if their borrowing costs would be excessive.

    An interest rate of say 2% + prior year budget deficit as a percentage of GDP was 4%, then an interest rate of over 6% would be considered excessive.

    If there was no budget deficit or a budget deficit of less than 1% of GDP, then an interest rate would have to be over 4% to be considered excessive.

    So if the offers come in at 7%, then a nation could borrow from the ECB at the rate limit to pay off the maturing debt instead and tell the market to take a hike down to the bank paying 2%.

    Nations might have to raise taxes to pay expenses, but old debt would always be manageable.

    Markets, though useful, can sometimes get out-of-whack.

    Countries wishing to borrow from the ECB would have to agree in their constitutions to give the ECB first priority to their VAT and income tax revenue to service their ECB debt.

  •  One possibility is to raise Italian (0+ / 0-)

    withholding (and income) tax rates so the Italian government doesn't have to buy overpriced new debt at every auction.

    Another possibilty is selling say 5% small denomination national savings bonds at various locations such as post offices.

    They might also allow payroll deduction purchase. Say one 20 Euro 5% bond a week.

  •  Dear Depositor: (0+ / 0-)

          As per Italian law XXXX, 10,000 Euros from your account YYY has been used to buy Italian national debt. Please come to the bank to pick up your 5%, 10-year bond.

            Your Banker

  •  Another possibility (0+ / 0-)

    is requiring property holders to buy national debt or have their property liened.

  •  There are other ways to deal with it. Strengthen (0+ / 0-)

    EU's fiscal authority which is what Merkel is talking about. Which essentially means having Germans loan a bunch of money to Italian via ECB. Krugman is saying smth different from what you're saying. His point is that ECB keeps obsessing with inflation. If it continues, all kinds of bad stuff including euro demise can happen.

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