Wednesday, November 9, 2011

We're Gonna Need A Bigger Boat

via Bloomberg
It is starting to really hit the fan in Italy as yields on 10 year Italian bonds hit 7.4%!  This was always the country that everyone was worried about when they were talking about the other PIGS (Portugal, Italy, Greece, Spain), and it looks as though Italy is almost tipping over.  This recent market action has been the main cause for the President of the Council of Ministers, Silvio Berlusconi, to resign.  This news has not stopped the market from driving up the yield for Italian bonds further.

Palazzo Montecitorio, Rome (photo: Marco Assini)

It remains to be seen what, if anything, the Eurozone can do to help the Italian bond market, as they have with Greece.  Economists and market watchers have long said that Italy is too big to get the same "fixes" that Greece received.  The wheels keep churning at the Italian Ministry of Economy and Finance, they'll be having new bills issued tomorrow, and more 10 year bonds next week.  This might be the one of the more interesting months in economic history, as it might see one or more countries exiting the Euro.  It seems the economics blogosphere is abuzz with that idea, and rumors are spreading that top French and German officials are already discussing how it would happen.

Most currency changes are done years in advance so that all market participants understand what is happening.  The Euro was introduced over a three year period, initially (1999) only electronically, and older currencies were still accepted physically until 2002.  It is likely that if the Euro shrinks in terms of countries, or if it is scrapped altogether, it will happen quickly.  If Greece reintroduces the Drachma, or Italy the Lira, it will be almost overnight.  This will be an awful shock to the economy.  Deflationary pressures will be enormous, and productivity losses could be severe due to loss in the medium of exchange because large economic areas won't have currencies for a period.  It will be ugly, but the uncertainty of how ugly is enormous.

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