Friday, July 12, 2013

Is Italy the Next Cyprus?


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S&P downgraded Italy earlier this week.
European financial experts project that Italy will need a financial bailout within six months. Italy has about $2.5 trillion in outstanding debt--meaning that any problems with a possible default will send a tsunami through global financial markets. So how likely is an Italian credit crisis?

Consider the following facts: Italy's economy has contracted for 7 straight quarters; industrial production has fallen for 15 straight months; since 2008 factory output has plunged 25 percent; poverty has doubled; and its debt has soared to 130 percent of GDP. Austerity has increased Italy's debt load, crashed its economy and spawned immense suffering among the Italian people. Or, as economics Professor Krugman puts it: austerity has been a "disastrous failure." He is not the only Nobel laureate who thinks that. Indeed, the stability of the government itself has been compromised and the high unemployment rate for Italian youth (38.5 percent) promises more political unrest.

Italy is also way behind on its bills and does not have the funds to pay. This in turn is leading to mass bankruptcies of Italian businesses.

A default sure seems credible from my view. What does that look like?

The place to start for that question is Cyprus. This was the most recent and most radical bailout by the EU, the IMF and ECB. Basically, this trioka of eurocrats deemed that depositors must pay and pay big for the errant ways of Cypriot banks. Thus, uninsured depositors were forced to become shareholders of insolvent banks (up to 60 percent of the amount that exceeds $130,000) and had most of the rest of their deposits frozen. Even insured deposits are subject to capital controls that have been in place since late March and will not be lifted until at least September: this means that all depositors can only withdraw about $400 per day, cannot cash checks, and face monthly limits on transfers out of the country. Who needs that noise, and how does one know it will not worsen?

Cyprus is the new "model" for Eurozone bailouts. Deposit confiscation, limited only by what the eurocrats think the government can get away with.

Given these facts who in their right mind would leave any money in Italian banks? And, if Italy proved too big to bail out, why would anyone leave money in Spanish, Portugese, and Greek banks? Under these circumstances Eurozone bank runs on a massive scale seem almost inevitable and certainly rational.

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