After months (years) of worry and occasional action on Greek debt, we now move on to Italian debt. Both are charter members of the PIIGS (so far, we are only missing Spain) the group of shaky economies in the Euro zone. Before the Euro, these countries would have faced major bouts of inflation with the devaluation of their currency, but that is difficult to accomplish in the current arrangement of a common currency. The equivalent method is reducing wages, and other incomes while leaving Euro-based prices of goods the same, but this is also difficult to implement in only a part of the Euro zone. Greece (and to a much lesser extent) Italy depend on tourism for the income to support the economy. The tourist industry doesn’t pay well and is very sensitive to price. Not a good recipe for driving a recovery.
The current trigger is that Italian bond rates have reached 7%. Historically this is not that bad, but compared to the US rate of almost 0%, this is high. But as an investor, 7% is a minimal premium for the default risk. (Default can be either complete and partial, where a partial default may just be a reduction in the bond value, or a forced reduction in the interest rate.) But then bond prices (or really the interest rate) have never adequately factored in the default risk and as the mortgage industry collapse has show, the models of independence of different investments are broken.
The good new: Italian debt is not directly held by US banks or in the US. The bad news, the US does have interests in France and the UK where much of the debt is held (most is in Italy itself, but France is especially at risk).
Should we be worried about Italy?
Yes. And, as in Greece, the only solution that works is when people are working and contributing. Too many of the solutions are to cut jobs, cut spending, and bleed the economy to prosperity.