S&P Wakes Up, Cuts Italy to One Notch Above Junk, Economy Sinks into Terrific Mess

Italy has one of the most troubled economies in the EU. Businesses and individuals are buckling under confiscatory taxes that everyone is feverishly trying to dodge. Banks are stuffed with non-performing loans that have jumped 20% from a year ago. The economy is crumbling under an immense burden of government debt that, unlike Japan, Italy cannot slough off the easy way by devaluing its own currency and stirring up a big bout of inflation – because it doesn’t have its own currency.

Devaluation and inflation used to be Italy’s favorite methods of dealing with its economic problems. It went like this: Politicians made promises that they knew couldn’t be kept but that bought a lot of votes. When everything ground down as industries were getting hammered by competition from across the border, the government stirred up inflation, and then over some weekend, the lira would be devalued. It was bitter medicine. It was painful. It didn’t even cure anything. It impoverished the people. But it temporarily made Italy competitive with its neighbors once again.

Most recently, Italy devalued in 1990 and then again 1992 against the European Exchange Rate Mechanism, a predecessor to the euro. Having to take this bitter medicine time and again had made Italians the most eager to adopt the euro. The idea of a currency that would be out of reach of politicians and that would function as a reliable store of value, run by the Germans as if it were the mark, and in turn, keep politicians honest – all that seemed like paradise.

But it just hasn’t kept Italian politicians honest.

Only this time, their favorite tools are gone. The economy is now a mess. Economic “growth” has been negative or zero for the last 13 quarters. It looks like this:

Italy-GDP-2011-2014-Q3

And the country’s debt, no matter of how hard the government tries to fudge the numbers, just keeps ballooning.

So, on Friday, ratings agency Standard & Poor’s woke up and cut Italy’s sovereign credit rating to BBB–, just one notch above junk, which is the dreaded BB. It cited the economy’s perennial shrinkage and lousy competitiveness. The deteriorating economic fundamentals and a political unwillingness to address the deficit were making the mountain of public debt increasingly unsustainable.

The ECB has been busy doing “whatever it takes” to keep the cost of funding this wobbly construct as low as possible. It lowered its own benchmark interest rate to near zero. It instituted negative deposit rates, it’s contemplating a big round of QE, all to keep Italy (and some of its cohorts) afloat a little while longer.

The last time S&P struck out at Italy was in July 2013, when it knocked the credit rating down to BBB from BBB+. This is a slow tango that is falling further behind reality. Without the backdoor bailout from the ECB, which is run by Italian Mario Draghi, Italy would by now be discussing fashionable high-and-tight haircuts with its creditors.

And that would be a good thing for Italy – but no, wait….

These creditors include Italy’s largest banks who’ve been the dominant buyers of this crappy debt, with money they get from the ECB for free. It’s the easiest way to profit. Why even bother lending to struggling Italian companies? Hence the ECB’s guarantee on the Italian debt. It must not be allowed to blow up.

It just hasn’t done anything to solve Italy’s problems.

Yet Italy is a country of entrepreneurs and of vibrant small enterprises. Or was. Now these businesses are dying. “We are crushed by our country’s debt,” one of them told me. Read… Italy’s Crazy New Economy from Hell

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  3 comments for “S&P Wakes Up, Cuts Italy to One Notch Above Junk, Economy Sinks into Terrific Mess

  1. NotSoSure
    Dec 5, 2014 at 8:50 pm

    What’s the bet that come New Year, Draghi is going to go ahead and force a confrontation with Germany?

    • Jungle Jim
      Dec 6, 2014 at 11:41 am

      I would like to think that you are right, but nothing I’ve seen so far is convincing. Draghi is a “good European”, one of the European political elite that created the euro. Those people, and there is a surprisingly large number of them, will go to any length whatever to preserve their “vision”. They are well aware that public support has withered but they don’t care. That is why they fight so hard to prevent referendums. Will Draghi betray the collective European ideal, I doubt it.

  2. LG
    Dec 6, 2014 at 10:44 am

    Most people are not aware that Europeans credit or consumer debt like auto loans are not even close to Americans. You don’t buy a car in the EU with 0 down 74 months neither they’re in 15k in credit debt. It’s mainly government debt and corporate loan defaults that is ailing the EU.

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