Debt and distrust are the greater economic risks

THE great focus on debt around the world is naturally due to the sharply rising interest rates in the financial markets, and one can certainly say that the financial markets and investors are very far ahead from both the central banks and politicians in understanding the current economic challenges.

One of the more profane examples is the explosion in the 10-year Italian interest rate. Part of the increase is due to the global interest rate movement, but the speed of the Italian interest rate rise should not be underestimated.

I regard this as a really serious development as this concerns the Southern European countries, especially Italy, and the risks can be enormous. Just to relativize this, the many losses in the financial markets this year are painful, but I remain to be in the optimistic camp wherein I'm arguing that it is a correction — and a big one, admittedly. After a correction, normal life returns at some point, and it is my expectation that investors around the world will experience the same this time.

Another relativization is the current inflation, which is painful in many countries and will affect the purchasing power of millions of households around the world. The inflation will calm down one day, and oil prices may well find a price level slightly below current prices, but it is not my expectation that consumer prices will generally fall back to the level from a year back or so. That being said, many households will feel the pressured economic situation a few years ahead.

The two relativizations are serious on their own, but Italy now risks being on its way into a structurally extremely difficult situation, which is much worse. The risk is a bottomless pit, where investors may lose confidence in the quality of the country's government bonds and, in general, the country's ability to pay — Italy is, after all, the third-largest economy in the eurozone.

Among my own megatrend forecasts, I have long worked with the view that the next crisis could arise as a sovereign debt crisis, in short, distrust of the ability of Western states to pay. It is a situation that simply must not emerge, though my argument has long been that one could project the unsatisfactory economic development combined with the lack of economic reforms. My expectation so far was that around 2030, more Southern Europeans would be trapped in an economic quicksand where the country would not be able to move forward using its own economic engine.

However, this is not the first time a megatrend expectation has been overtaken by reality. The situation is so blatantly serious that the European Central Bank (ECB) felt compelled to convene something extraordinary due to market turmoil. This was hardly to mourn the approximately 10 percent many balanced investment portfolios have lost so far this year. Behind the nice wordings were developments, such as those in the Italian bond market.

The Italian government debt, in relation to gross domestic product, obviously set new heights through the Covid-19 pandemic, just as it did during the financial crisis. It is obviously considered legitimate to incur further debt simply because other countries do, but many other countries have made sure they had fiscal leeway to be able to borrow without reaching a level where the country's creditworthiness risks tilting.

As a slight form of self-criticism, I hope that the ECB regrets not having intervened with Italy, the debt and missing economic reforms.

If European central banks had acted, for example, in the interests of homeowners, the greatest risk to the housing market would have been addressed, and it may as well be Italy. If the country gets further out on an economic slippery slope due to excessive debt, it can really cause turbulence, including the overall European debt market, which is very worrying.

Instead of implementing deep economic reforms since the global financial crisis, they continued to party in Rome. The short-term solution will obviously be more bond purchase programs from the ECB, so that the central bank can keep Italy's financial budget alive. But the bill has not been paid and my best bet remains that there will be a common solidarity tax in either the whole European Union or in the eurozone in order to settle the bill in Italy.

Source: TheManila Times