Italy: Illiquid-but-Solvent

Evidence for the argument that Italy is having a liquidity crisis, not a solvency crisis:

Italian Yields Top 7%

Italian bonds slumped, driving two- five-, 10- and 30-year yields to euro-era records, after LCH Clearnet SA raised the deposit it demands for trading the nation’s securities.

Two-year note yields rose above 10-year rates, with five- year debt climbing above 7.5 percent as Prime Minister Silvio Berlusconi’s offer to resign left his weakened government struggling to implement austerity measures to reduce borrowing costs.

…The yield on Italy’s five-year notes jumped 82 basis points, or 0.82 percentage point, to 7.70 percent at 11:56 a.m. London time.

Investors are demanding a risk premium on all maturities of Italian bonds. However, the fact that that the risk premium being demanded is now higher on shorter maturity bonds than on longer maturity bonds implies that market participants believe that Italy’s potential difficulties in repaying its bonds are concentrated in the next couple of years, and that if Italy can get through that stretch then the risk of default diminishes.

This is not to say that there couldn’t also be some concerns about Italy’s long-term solvency; but those concerns are clearly being overshadowed by worries that Italy may not make it through its current liquidity crisis. Which means that no matter what steps are taken to change Italy’s long-term budget picture, if Italy isn’t provided with the liquidity it needs to get through the next couple of years, then long-run solutions are really rather irrelevant.

Liquidity, liquidity, liquidity.

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About Kash Mansori 46 Articles

Who is this guy, anyway? And is Kash his real name?

Yes, Kash Mansori is my real name, and I've been writing online about economics since 2003, with a few breaks here and there. After receiving my PhD in economics in the late 1990s, I did a tour of duty as an economics professor at a small liberal arts college in northern New England. The charm of 6-month long winters eventually wore off, however, and I left the academic world in order to move south to warmer climes. I now live in North Carolina and make my living providing economic consulting services, primarily to US and European companies in the manufacturing, high-tech, and finance industries. I have a couple of kids, I enjoy cooking, and I have maps hanging all over the walls of my house.

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