Financial markets swooned after Italian Prime Minister Enrico Letta and his new cabinet were sworn in on Sunday, but Italy’s troubles are far from over. From the WSJ:
Financial markets continued to applaud political progress in Italy Monday, extending a rally in the country’s stock market and allowing Italy’s government to secure the lowest funding cost at a debt auction in over two years…
The temporary injection of positivity is more air in an already-full balloon. Easy money from the US and Japan have been boosting the market over the last few months and hiding the true extent of Italy’s underlying troubles, according to my colleague, Des Lachman. When the global liquidity market changes, Italy will be hung out to dry.
Buoyed by very cheap money in the United States and Japan, international markets are choosing to ignore Italy’s deteriorating economic and political fundamentals. Instead, markets seem to be taking comfort in the European Central Bank’s commitment to do “whatever it takes” to save the euro in general and to provide a backstop to the Italian and Spanish government debt markets in particular by buying unlimited quantities of those countries’ bonds.
Rose-colored glasses are nice, but in this case, sustained market optimism could prevent necessary reform. Underestimating the true extent of Italy’s problems puts its long-term solvency at risk because there is no feedback mechanism or pressure to fix the growing level of public debt, according to Lachman.
The market is hardly doing Italy a service by failing to signal the unsustainable path on which Italy’s public finances now seem to be. For it enables the Italian political system to continue on a business as usual basis and to delay the needed economic reforms to address the country’s excessive public debt problem. This runs the very real risk of making the Italian economy all the more vulnerable to a change in global liquidity conditions when that occurs.
So Prime Minister Letta, don’t raise your glass just yet. Italy needs structural change for a real recovery to take place.