We may be nearing the finale of the euro crisis that has been building for at least a year and a half. What Italy does now, and how governments and markets respond, may determine whether we have been watching a tragedy or something less serious. Whatever it is, it definitely has elements of both.
Eurozone governments and the European Central Bank would be well-advised to prevent an Italian default at almost any cost (as the rest of the world has been screaming recently).
However, there are three reasons we might be watching a tragedy and not a drama with a happier ending. First, backing Italy means someone has to take a huge amount of financial risk. The probability of loss would be low, done right, but the maximum potential loss would still be high. No one is eager to step forward.
Second, Germany, Europe's deep pocket, is understandably insistent that any support comes with very tight stings attached to ensure the money is not frittered away. Italy's political system is deeply flawed right now, making it very difficult to provide assurances -- hard for even a sounder country to provide.
Third, the governance of the eurozone requires an amazingly complex dance among 17 countries, each with their own politics, financial systems, and economic circumstances. There are many, many ways that the complexities could prevent the necessary steps. I think that an Italian crisis is likely to eventually force strong, concerted, and comprehensive actions that will save the eurozone.
But, there is maybe a one in four chance of disaster. As I have advised before, keep your fingers crossed. A collapse of the eurozone would plunge the US into recession again.
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