The likely appointment of Lucas Papademos as Greece's new Prime Minister, charged with implementing the Eurozone bailout deal, should be received positively by the markets. Papademos served as deputy to Jean-Claude Trichet at the ECB a few years ago, and has a high level of credibility with both investors and Eurocrats. That credibility is, apparently, untarnished by the fact that before going to the ECB, he was head of the Bank of Greece, at a time when data about the country's economic and financial performance may have been subject to, how can we put this delicately, a certain amount of massaging.
There's an obvious comparison, though it may not be one that resonates too much with the Greeks, with the role played by Kemal Dervis in Turkey during that country's severe economic crisis at the start of the last decade. Dervis, a long-time player at the World Bank, was parachuted back into Ankara as Minister of Economic Affairs, and deserves much of the credit for the remarkable turnaround that Turkey has since achieved. If Papademos can do as well, both Greece and the Eurozone will be able to breathe a lot easier.
Of course, with things looking a mite more stable in Greece, markets have shifted their focus. The media formulation is that investors are now "worried" about Italy, but a more accurate way of putting it is that some investors have identified Italy as the next place they can make money by stirring up trouble.
Italy's main problem (aside from the ludicrous Silvio Berlusconi) is the level of its outstanding debt, which equates to about 120% of GDP. Its current budget deficit of less than 5% of GDP is well below those of many of its Eurozone partners, not to mention the US and UK. Moreover, and again in contrast to the US and the UK, Italy is a nation of savers, and has not historically relied to any great extent on foreign buyers to support its government bond market. That has, of course, changed somewhat since the inception of the Euro, which has led more banks to become involved in the market. Even so, Italy's debt situation cannot reasonably be compared with that of Greece.
Be that as it may, the result of the market's "worries" is, according to the media, that "Italy's borrowing costs have soared to unsustainable levels". As usual, this says more about the media than it does about Italy. While the effective yield to maturity on Italy's outstanding debt has certainly risen, the actual interest cost that the country has to pay has risen only slightly, if at all. The higher rates demanded by the market only have an impact when Italy is forced to raise new money, or to roll over previous debt. Even if an interest rate of 7% is "unsustainable", as media pundits keep saying (and just where does that figure come from anyway?), it would take several years of refinancing and new borrowing at current interest rates before Italy's actual interest costs even approached the 7% level.
This suggests that the ECB and EFSF should resolve to worry less about the falling value of Italy's outstanding bonds, and focus more on ensuring that the country's upcoming borrowing needs can be met smoothly. That in itself will be a challenge: a large tranche of Italy's debt comes due before the end of 2012. Still, it is a lot less daunting than pouring money into trying to preserve the secondary market value of Italy's entire existing debt stock, especially as only the most pessimistic believe that Italy will not ultimately be able to meet its obligations.
That last point -- that Italy is still solvent -- was cast in an interesting light by the recent failure of MF Global, supposedly as a result of its high exposure to peripheral Eurozone bond markets. Discussing the situation on CNBC, one commentator blurted out that MF's holdings of Italian and other PIIGS' bonds were almost certainly "money good". In other words, they would almost without doubt be repaid in full when due. What this means is that MF didn't collapse because Italy's or Portugal's balance sheet was rubbish; it collapsed because its own balance sheet was rubbish.
Debt markets, dysfunctional? You might think that. I, as a former international bond guy, couldn't possibly comment.
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