The financial shockwave caused by Italian government bond yields hitting 7.48% is causing speculation of a pan-European meltdown and the possible end of the Euro single currency union. Italy is the 4th largest sovereign borrower after the U.S., Japan and Germany, with debt exceeding those of Portugal, Ireland, Greece and Spain, combined.
By all accounts, Greece's troubles, already the cause of a low grade migraine for the European Central Bank and the governments of Germany and France, is child's play, compared to the possibility of a run on Italian debt obligations. Credit Default Swaps, the cost of insuring Italian debt, is at a record high. Already, sovereign debt yields across Europe are rising in tandem with the situation in Italy.
However, Italy's debt level, though high at 2 trillion Euro or 120% of GDP, is still manageable due to a much smaller operating budget deficit. Therefore, unlike Greece, where even structural reforms are unlikely to create investor confidence, Italy can still extricate itself by embracing serious fiscal reform. She should take a page from New Zealand's bold reforms in the mid-2000s, which led to a resurgence of the latter's economy.
Italy still boasts robust manufacturing and agriculture export based industries. Her service industries related to tourism continue to garner healthy inflows of foreign exchange. By defanging the unions, reducing public expenditures, lowering taxes on investments, reducing the distortions caused by undue business influene on public affairs, taking visible and concrete steps to collect what is owed to the public purse, Italy can restore investor confidence and halt the run on its debt.
What it should not do is follow Greece's example of financial re-engineering, such as calling for an ECB bailout before domestic reforms are taken, forcing holders of her debt to take haircuts, and blaming outsiders for its financial troubles. Such strategies serve to reduce confidence, not increase it, as they externalize problems caused by the country's political class.
The crash of Italian debt quality is a global referendum on the current Italian government, not its core economy. Prime Minister Berlusconi's offer to resign at some later date, only to annoint a successor, does nothing to instill investor confidence. Instead, he should dissolve Parliament, and call for elections without endorsing any candidate. Unfortunately, like Greece, self-interest will likely trump patriotism. I'm selling Euros, for now.