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Wednesday, November 09, 2011

Ciao, Italia!

Italy is gone:
The yield on Italy’s five-year notes jumped 27 basis points, or 0.27 percentage point, to 7.14 percent at 9:44 a.m. London time. The 4.75 percent securities due in September 2016 dropped 0.98, or 9.80 euros per 1,000-euro ($1,372) face amount, to 90.825.

The two-year note yield climbed 43 basis points to 6.81 percent. Ten-year rates rose 19 basis points to 6.96 percent. The difference in yield between the Italian and German 10-year yields increased to as much as 520 basis points, or 5.20 percentage points.
Not only do these yields mean that any hope of Italy staying in the Euro and paying its debts is gone, but they also predict a hefty recession.

The nice thing for Italy is that it was running a primary surplus before the 2008 crash. Thus it can afford to default, whereas Greece can't afford to default. You can't go short when your yields are rising like this, but when your longer term yields are over 600 basis points and your outstanding debt is over 100% of GDP, the mathematics are inexorable. Running a primary surplus of six percent when your median age is over 45 years is not possible, and that's what Italy would have to do to stay in the Euro without being allowed to write down its debt about 25%.

Since both the Italian services sector and the Italian manufacturing sector are in a hard contraction, and since the last Euro-solution offered was tantamount to telling any private sector holders that they would take more than their share of the aggregate loss, the increase in Italian bond yields is deeply rational. Indeed, Mr. Market hasn't caught up with Mr. Grim Reality yet - those ten year yields should be much higher, based on the economy, the demographics and the direction of the Euro crisis resolution. The only reason they are not is that Italy can leave the Euro.

A bunch of Italian banks are now insolvent and will have to be bailed out by the Italian government. Italy will have to move pretty quickly to avoid the EU-declared fiscal Blitzkrieg:

I don't have precise figures, but Italy can probably restructure at 90% or 80% of GDP by handing foreign holders an implied 50% loss. They will probably negotiate to make that closer to 30%.

Internal Italian sources probably hold about 60% of their debt. One can imagine that it is being shuffled around quite quickly.

Italy has a large gold reserve (more than the ECB - only the IMF, Germany and the US own more), and most of the population isn't that indebted, so it can probably flee to the lira, devalue the external portion of the debt by 20-30%, and struggle along paying for energy imports.

After the EU's recent performance, I think Italy should feel no compunction about leaving the Euro and staying in the EU. The EU can whine all it wants to, but can it really afford to retaliate? Italy has enough debt out there to give it some strong negotiating leverage.

Now, if you assume that Italy goes back to a national currency, and shuffles off a decent portion of its externally held debt by devaluation, then the ten year prospect doesn't look so bad. Thus I assume that many traders are assuming that Italy will exit the Euro and move itself to stronger growth patterns doing so.

Note - as I was writing this article, Italian yields were still climbing.

This is how quickly it tips!

The Euro crisis has reached its acute stage.

France is next in the Fall line - Ireland probably won't be able to get its promised funding stream, so that gets dicey too.

It's nice for the UK, though.

It would seem that the Italian fixed yields are somewhat variable. ;)

"Fixed fortifications are a monument to the stupidity of man." - Patton
Bloomberg is posting yields rising like floodwater - the 2 is now well over 7%, the five year at 7.70% 7.5%.

Impressive, to be sure.
It looks like settling close to 7%, but that's that.
Thanks. Intriguing.

I think the UK government's escape pod has been the weak £ - but they can kiss that hope of recovery goodbye. Weak €/long European recession leaves the UK relying on state jobs & benefits to keep the money flowing.
Frankly never bought into Italy's bonds, the wine,cheese and pasta now that always was something special. Hopefully they will continue to export there best cheese once they dump on the French/Germany/English banks.
The austerity that is being forced upon the PIIGS just
kills money velocity and therefore any hopes of a recovery.
Eventually printing will occur and savers will have been
screwed again. Unfortunately printing or austerity will lead
To a lower standard of living .
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