One of the most famous comic characters of modern Italian literature is the feisty communist mayor Peppone, created by the writer Giovannino Guareschi as a foil to his priestly hero Don Camillo.
In one story Peppone comes into some money and develops a paranoid and very uncommunist fear that he will lose it. Where on earth can he keep it safe, he anxiously wonders? One can be sure that these days he wouldn’t be putting it in Italian government bonds.
The yield on the ten-year jumped to a euro-era high of 7.5 percent last Wednesday on concerns that Italy lacks a credible plan to bring its debt down. Investors worry that when the European Central Bank stops its emergency buying of Italian debt at some point in the future, yields could shoot up to a level where Italy becomes unable to pay them without (and possibly even with) longer-term international support.
So where could a present-day Peppone safely preserve his riches within the western European sovereign bond market – long seen as one of the world’s major safe havens for investment?
It’s not far-fetched to see fears about solvency spreading from Italy to other eurozone countries through a form of bond market contagion – because this is precisely what happened to Italy itself. Banks and fund managers eventually accepted the prospect of massive losses from haircuts on Greek sovereign bonds. But their determination to avoid the same experience again is driving them away from a country bedevilled by the same low economic growth and porous tax system which caused the Greek debt crisis. What’s more, questions are already being asked about the ability of other eurozone countries, aside from Italy, to generate tax revenue.
Fear is contagious too – and fear is the other reason why the Italian debt market is in an imbroglio. Traders’ prediction of unsustainably high Italian yields risks becoming a self-fulfilling prophesy: if fears about Italian bonds keep 10-year yields above 6 percent or so for many months, Italy’s E1,900 billion public debt will be too big to sustain because of the mathematics of such high payments. Franklin Delano Roosevelt may defiantly have said back in 1933 that “the only thing we have to fear is fear itself.” But in an October 2011 report on eurozone sovereign debt the rating agency Moody’s pointed out more realistically (though less elegantly) that “loss of investor confidence has become a key credit factor”.
If Moody’s is right, then investors should be worried about Spain, whose 10-year yield has risen 17 basis points to a hefty 5.87 percent since Wednesday, on frightened talk about its high fiscal deficit – estimated by UBS at probably above 7 percent of gross domestic product (GDP). Even if Spanish yields do not rise any higher, these levels could already be unsustainable because of the distressingly high payment burden. Another country hit by the fear factor is Austria – whose 10-year yield has leapt 32bp to 3.35 percent largely because of concerns about its banks’ large portfolio of loans to Italy. Even France’s benchmark 10-year bond has climbed by 20bp to 3.36 percent since Wednesday, as nervous investors ponder its gaping 5.7 percent budget deficit. The French newspapers have responded to anxiety over the safety of the nation’s AAA debt rating – which has become as iconic to France as the statue of Marianne and the Gallic rooster – by printing his name as Saaarkozy.
But investors seeking safe havens can always rely on Germany, can’t they? The yield on the 10-year bund actually declined slightly on Wednesday, and closed the week at a modest 1.89 percent.
Not necessarily. If Italy needs to be bailed out and eurozone governments have to do it, much of the burden will fall on Germany, because its debt situation is better than other major eurozone economies’. But, of course, the debt picture would look very different if Germany had to bail out Italy – its triple-A rating would be jeopardized, sending yields significantly higher.
But if Europe’s largest economy chose the alternative of not bailing out Italy, the damage to the European financial system would produce a slump in German output and hence tax revenues - endangering its triple-A rating as surely as would the burden of bailing out Italy. It could even prompt questions about the latter-day safe haven status of UK gilts, since about half Britain’s trade is with eurozone member states.
A latter-day Peppone might perhaps be best off putting his money outside the EU altogether in the unusually solvent kingdom of Norway, whose bond market yawned in a bored manner at the Italian farrago before falling slightly to close the week at 2.42 percent. Its gross debt to GDP ratio is under 60 percent, according to the most recent estimates from the Organisation for Economic Co-operation and Development. On a net basis – which is less commonly quoted for national governments, but is seen by many economists as a truer guide to solvency - its assets outnumber its liabilities to the tune of 160 percent of GDP. This oil-rich country has carefully husbanded its financial resources to the point where its debt can be seen as immune from default by the most fear-ridden of investors – even Peppone.
