Italy's Eurozone Crisis Is Just Beginning

If there is a theme to the news these days, it is that Italy is on the road to becoming Greece II. And Greece is on the road to becoming the first country to exit the Eurozone.

The 10-year bond interest rate being demanded by lenders to Italy is hovering at around 7%. This is what financial analysts call the “tipping point,” that is, the interest rate that must be paid by a government borrowing money (i.e., selling bonds) to manage its budget is too great to be paid with the money available from taxes and other government income. So, sooner or later, the government will be in default and the lenders will have to either try to force the country to pay them without regard to the citizens’ needs, or the lenders will simply mark the bonds they bought as unrecoverable. This will put a hole in the banks’ capital account and someone will have to lend the banks money to fill the hole.

This hasn’t happened in Greece or Italy yet because the European Central Bank is buying their bonds - to support the interest rate at below 7% for Italy and simply to funnel money to Greece so it can continue as a going concern because its interest rate on 10-year bonds is above 30% and no one except the ECB is buying them.

That Mario Berlusconi was forced out as Italy’s prime minister really is of little positive significance. He has held the Italian government together through his coalition with the far right Northern League for almost 20 years. If you consider that Italy has had more than 50 prime ministers since the end of World War II, you will see that Berlusconi has done a remarkable job in keeping a government functioning in Italy for such a long period. We must now await the results of Mario Monti’s effort to forge a solid coalition that can push through the austerity measures demanded by the Eurozone and the International Monetary Fund. Monti will probably get this job done, but in the aftermath, with budget tightening pinching the lives and living standards of almost every Italian family, he will need the support of the Northern League and Berlusconi’s party to continue to govern. Without these two parties, Monti could not survive a confidence vote in the Italian parliament.

Don’t believe that the Eurozone crisis is over, or that the Euro as a currency has been saved. Neither is out of the woods.

And, there is still whispering in Europe about Greece exiting the Eurozone and going back to its Drachma early next year. Will Italy follow and revive the Lira? Will Spain decide to go back to its old currency?

And, the biggest unanswered question of all, how long will Germany continue to be the lender of last resort for the rest of the Eurozone, paying to keep the Euro currency on life support while the rest of the Eurozone longs for the good old days when they actually had control over their currencies, their budgets and their individual destinies.

The year 2012 will be interesting, and not just for US presidential politics.