The good news this week was that Greece, on schedule, made its €750-million debt payment to the International Monetary Fund. The bad news was that it had to raid its own IMF currency reserves to do so. Draining one IMF account to pay another IMF account is the act of a desperate country.
Another Greek bailout is essential, all the more so since fresh data released Wednesday showed that the country, after a flirting with growth last year, is firmly back in recession. Heaping more debt onto a country that will never be able to pay off that debt seems folly. Why not let the country go bankrupt so it can write off its debt, leave the euro zone and reprint the drachma? Clearly, euro zone membership has been a disaster for Greece.
The answer is that the next Greek bailout, like the previous two, will have little do to with Greece itself and a lot to do with its washed-up Mediterranean neighbours, notably Italy. Protecting them from contagion is the priority. The euro zone will live or die in Rome, not Athens.
The European Union, the European Central Bank and the International Monetary Fund would have you believe the fallout from a Greek default and exit from the euro zone – Grexit – could be contained. But if the trio of creditors were so assured that any contagion would be the equivalent of a small, deep earthquake – short-lived and limited to tremors, not wholesale destruction – why are they obsessed with another rescue?
To be sure, ECB president Mario Draghi has played a credible role as the euro zone's Mr. Fix-it. In 2012, when the lights in the euro zone were dimming, he announced a bond-buying program whose mere presence – it was never actually deployed – sent bond yields plummeting in Italy, Spain, Portugal and other stressed-out countries. Even Greece's yields came down to the point it could flog short-term bonds. Another layer of protection came early this year, when Mr. Draghi launched a quantitative easing program that will see the ECB buy €1.1-trillion ($1.5-trillion) of sovereign and private bonds to stimulate the economy and prevent outright deflation. The euro zone's 0.4-per-cent growth in the first quarter shows that QE, combined with low oil and cheap debt, is doing the trick.
With the ECB's disaster-insurance measures in place, and the euro zone economy improving, you would think that now is the time to declare Greece a lost cause and let it go. Indeed, the amount of financial, economic and political capital devoted to a country worth a mere 3 per cent of euro zone gross domestic product is obscene.
Or is it? It's not, if all those resources devoted to saving Greece is really designed to protect Italy. While the EU and the ECB can talk forever about the euro zone's ability to withstand the shock of Greek collapse and Grexit, no one knows what will happen because, so far, the euro zone has been a one-way street; since no country has left, there is no telling what might occur.
What we do know is that during the height of the "debt" crisis in 2011 and 2012, Italy's bond yields surged to 7 per cent – the crisis level that pushed Greece, Ireland and Portugal out of the debt markets and into bailout programs. While Italian yields have sunk – the treasury can now sell 10-year debt at 1.9 per cent, similar to Canada – the Italian bond market is hardly contagion-proof. When Greek bond yields do their little volatility dances, perhaps due to a standoff with the EU or rumours of a bank run, so do Italian yields. In the last month, Italian yields have climbed 0.6 percentage points. Spain's and Portugal's have climbed by similar amounts.
Among the largest euro zone economies, there is no doubt that Italy is the most vulnerable. It has spent every year since 2008 in deep recession or stagnation (though it did manage to eke out 0.3-per-cent growth in the first quarter). Its unemployment rate is still rising and hit 13 per cent in March, well above the EU and euro zone average. As the economy goes nowhere, debt keeps rising. Its debt to GDP ratio is forecast to hit 133 per cent this year, the second highest in Europe, after Greece. Corruption is endemic and the country is allergic to reform, in spite of the best efforts of Prime Minister Matteo Renzi. Big corporations are walking to the Italian border and saying arrivederci. Fiat, now part of the Fiat-Chrysler group, is creeping out of Italy. The group's primary market listing will soon shift to New York from Milan.
Some economists think Italy is essentially a lost cause. "The global crisis has exposed severe structural flaws in the Italian socio-political-economic system and not created them," said an April paper written by Gianluigi Pelloni and Marco Savioli for the Rimini Centre for Economic Analysis. It concludes that Italy is trapped in an "anti-growth culture, hindering restructuring."
Italy's debt, at almost €2.2-trillion, is unsustainable and poised to send its economy to the edge of disaster, or beyond, unless compelling growth returns. The Italian economy is the third largest in the euro zone and considerably larger than Canada's. Italy is too big to bail out and its collapse would sink the euro zone, end of story. The EU, the ECB and the IMF aren't determined to bail out Greece again to save Greece. They're worried that the wave of contagion from Greece's collapse could swamp Italy.