11th July 2011

At first it seems quite familiar as the further spread of problems to Spain and Italy may seem more of the same. However in my opinion there is a clear extra factor which is the relative size of the two economies. Up until now the Euro zone has been intervening in economies which it had the ability and firepower to take control of if it wished. But Italy in particular is a different kettle of fish as it is the third largest economy in the Euro zone and accordingly any sizeable rescue here would have the effect of calling into question the credit rating of the countries intervening. Also the existing Euro zone bail out mechanisms are simply too small to cope with problems with Italy.

The Italian problem

If we go back to the inception of the Euro it was Italy that was always expected to be the problem child. This problem was often expressed by describing Italy as a high debt-low (economic) growth economy which if you think about it had the implication that sooner or later the growth would prove insufficient to support the debt. If Italy was a boat it would be one with a high waterline prone to being swamped by waves.

If we break that relationship down and just start with the debt side of the argument we see that the gross Italian national debt is nearly 120% of its economic output as expressed by its Gross Domestic Product. The benchmark for a country which has issues in this area is usually considered to be 100% so, as I replied to a comment over the weekend, the surprise is not that Italy is under pressure now but that it has not happened before.

Also the debt has arisen because Italy's government has simply spent a lot more than it has received in taxes. Before you point out I am stating the obvious what I mean by this is that there has been no specific cause such as a housing crisis (Spain and Ireland) or bank blow-up (Ireland) but a generic one of over-spending. If there is a similarity to the countries in trouble right now it is with Greece's inability to fully collect its taxes as Italy has issues too in that area.

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