Bad News Trumps Good News

November 8, 2011

It’s being reported that Lucas Papademos will be chosen to head up the Greek Unity government.  With a doctorate in economics from MIT and prior experience as the Governor of the Bank of Greece and Vice President of the ECB, Mr. Papademos is highly regarded and the best candidate for this temporary position until elections in February.  Chances are promising that, under the stewardship of Papademos, the Unity government will affirm its support for the fresh austerity required by the October 27 EU agreement, and this will allow the country to secure its next EUR 8 billion loan installment and avert immediate elections that would be highly chaotic at this juncture.

Across the Adriatic in Italy, the news is unsettling.  Berlusconi won today’s vote but arguably suffered a technical knockout.  He captured just 308 of 630 parliamentary votes, well below the 316 needed for a majority.  Those who opposed the prime minister abstained instead of supporting him, and abstentions outnumbered yes votes by 321 to 308.  This arithmetic in conjunction with broadening calls for Berlusconi’s immediate resignation offer no hope that Italy will approve a credible deficit-cutting plan so long as Berlusconi holds power.  The Italian bond spread versus German 10-year bunds was as wide as 495 basis points versus 354 basis points a month ago and 248 bps right after the EU debt accord of July 21.  An immediate fear of raised margin calls on Italian debt has been fanned today by unconfirmed rumors to that effect.

Italy’s difficult political dynamics are historically the stuff of legend and have been complicated by a slide back into recession.  Austerity will only make things worse, but market constraints leave no alternative.  Italy’s October composite purchasing managers index scored a 43.1, suggesting that fourth-quarter GDP growth could be negative 1.0% or worse. The service-sector PMI of 43.9 constituted a 28-month low, and the manufacturing PMI index of 43.9 was the sixth sub-50 reading for Italy in a row.

The emergence of Italy’s debt threat has compressed the EU crisis timetable, jumping over Spain, which had been the presumed next domino in this chain reaction that began with Greece and then infected Ireland and Portugal.  Italy raises the stakes for Euroland to a whole different level (see previous update in deeper analysis), and magnifies infinitely the danger to other economies of the world.  Italy is the fourth largest sovereign debtor.  The best scenario now would be for Berlusconi to step down without further delay or fuss, but such a move would be out of character for him. 

Copyright 2011, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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