Euro-zone breakup!

It is feared that Italy is losing the market access; Given the interest rate for sovereign debt is hovering at 7%, there is an immediate need to restructure the public debt of €1900bn that will take care of the “stock ” problem. However, the account deficit, lack of competitiveness, and a worsening plunge in GDP and economic activity that is the “flow” concern, is not going to resolve.

A credible lender of last resort is needed in Europe.  There are many options but look implementation scenario looks bleak:

• Eurobonds are out of question as Germany opposes them and will require a change in the treaties that will take years to implement.
• Quadrupling the euro zone bailout from €440bn to €2000 is a political non starter in the core countries.
• ECB can bailout Italy or Spain by buying back the debt but would take a huge credit risk and contravene the treaty no bailout clause.
• EFSF, which is a CDO, where bunch of sub triple A rating sovereigns are trying to achieve triple A ratings via bilateral guarantees, cannot be turned into a €2000bn fund with all the financial engineering.  It can spare only €200 for Italy or Spain.
• Even a technocratic Italian government cannot orderly restructure its soverign debt, given the debt to equity ratio of 120% and Italy needing a primary surplus of over 5% of GDP just to stop its debt blowing up.
• In order to define its structuring policies and restore growth and competitiveness (by currency devaluation or depressionary deflation), it is felt that Italy needs to be forced to give up the Euro and convert its euro debts to national currency debts. Such an action will effectively break the currency union.

Only ECB, if it becomes an unlimited lender of the last resort and policy rates to 0, - combined with fall in Euro in parity with the dollar; fiscal stimulus in Germany and Euro core; and austerity in periphery countries - could prevent this disaster.