Italy not immune to crisis

The conventional wisdom has been that without quite doing anything right, Italy finds itself largely immune from the growing world economic crisis.
 
Not that times on the boot-shaped peninsula aren’t hard. But Italy, for the most part, remains a cash economy, meaning Italian institutions have managed to sidestep most of the direct impact of the credit problems that have crippled other industrialized economies. And with a cynical public already weary of the government’s handling of affairs, there wasn’t much room for consumer confidence to fall once the global economy started sputtering.
 
Sure, tourism has taken a hit as cash-strapped vacationers decide to stay closer to home. And, of course, Italian investors were no less likely than any others to have put their money in ill-fated companies like Lehman Brothers or AIG. But there’s little doubt that the ripple effect has been smaller in Italy than in most other places.
 
All that said, it's too early for advocates of Italian-style financial Luddism to congratulate themselves. There are two characteristic aspects of the Italian economy that could help assure that the world's economic turmoil could hit harder and last longer in Italy than in other major economies: a lack of diversity among major financial players and the enormous weight of Italian state debt.
 
On 10 January, Italy's antitrust authority released a report showing that four out of five Italian financial institutions employ at least one director who is also a director for a rival institution. The authority's concern was that such a structure makes those companies less aggressive competitors, and that it could act as a barrier to entry for outside players trying to get into the market without the right combination of powerbrokers on their board.
 
Those concerns are valid, but they could prove to be ancillary when compared to the potential financial fallout of that kind of structure. In Italy, board seats are almost always given out to large shareholders (in other countries board members are often appointed for their influence or expertise), meaning that this cross-pollination of power is also evidence of cross-integrated ownership.
 
That tendency creates an array of problems. But the most serious one in this context is that it makes it much more difficult to contain deep financial problems in a single sector. A sector-specific problem could quickly spread to healthier sectors as a few spooked shareholders could unload shares across the board, sparking a run.

Italy's public debt is an even more worrying, creating the possibility that bonds may not be a long-term refuge for risk-adverse Italian investors.
 
At the start of the year, Italy's national debt was nearly 105 percent of its gross domestic product, the highest level in the EU and among the highest in the world in GDP terms. In absolute terms, it totals more than US$2 trillion; the world's third biggest behind only the US and Japan, both of which have far larger economies.
 
The larger a country's debt burden, the more new debt it must sell just to satisfy maturing bonds and interest payments. And with the euro now in use in 16 countries, the only factors that differentiate Italian bonds from those from countries with less debt and seen as more stable - e.g., Austria, Germany, Finland and the Netherlands - are the perceived risks and the rate of return. With the need for fresh cash and perceived risk both growing, interest rates will start to rise.
 
That is already happening: The difference in the yield between Italian and German government bonds swelled to nearly 150 basis points in December, compared to 35 basis points a year earlier (the gap has contracted slightly since then).  It's not hard to imagine a future where that burden becomes too much for the Italian government and its anemic economy to bear.
 
It's a reality Italian politicians are starting to glimpse. In December, Minister of Welfare Maurizo Sacconi uttered the forbidden word "default" while discussing the country's bourgeoning debt, drawing on the parallel between the Italian economy and that of Argentina before the 2001 devaluation of the peso. Sacconi's remarks sent shivers through skittish financial markets until the government went into damage control.
 
No economy as important as Italy's has defaulted on its debt since Weimar Germany in the 1920s, and - to be fair - few think such a development is imminent for 21st-century Italy. But such a fate is now mentionable.
 
The EU is the main reason it will probably never happen. Unlike Germany in 1923 and Argentina in 2001, Italy's economy does not stand alone: Brussels knows that widespread Italian default would be disastrous enough that it could take the euro currency down with it. Unfortunately, a major European intervention to stabilize Italian government bonds would be only a little less painful.