Is Italy Next?

Italian FlagItaly, the last line of defense for Europe…

In August, I was browsing a merchant’s shop in Italy that displayed the Visa and MasterCard logo.  When it came time to pay for a €20 souvenir, I pulled out my Visa Debit card but the merchant refused and wanted cash.  I obliged, paid cash and was given no receipt.  No official transaction occurred thus no sales taxes were collected.

Last week in a meeting with a colleague, who has travelled and had numerous business dealings in Italy, we discussed this transaction.  This practice is very common in Italy and he estimated that 10-20% of their economy is “under- the-table.”  (And this is one of the top 10 economies in the world!  A member of the G8! )  Much of that comes from dealings like I describe above as well as software piracy.  While the black market will never go away completely, changing policy and enforcing copyright laws and ensuring the collection of basic taxes that are already in place could go a ways to increasing revenue for the struggling nation.

It’s hard to find fault with someone for not wanting to pay (or collect) if a sales tax jumps 73% overnight.  That is what is happening in Greece as part of their broad austerity package.  On September 1, 2011 the VAT on the hospitality industry increased from 13% to 23%.  The response from affected business owners was simply that they weren’t going to collect the higher amount.

Below is a chart of 2010 debt to GDP ratios for some European nations.  Greece is squarely being targeted at this moment.  Last year is was Ireland, before that Iceland.

2010 Debt to GDP

A Greek default is being figured already, however an Italian default is not.  Is Italy next?  Italy’s economy is about eight times the size of Greece with close to $2.4 trillion in debt.   A strong move by the ECB, member nations and even the Chinese could stop the crisis of confidence.  Last week, Italian government officials were meeting with China’s largest sovereign wealth fund.  It is interesting that the Chinese are in a position to determine so much of the economic outcome of the West.  But would that be enough?  Even if it is enough to save Italy, it might just shift the target to Spain or Portugal or even France and the French banks.

Member nations of the EU need to step up their commitments and go “all-in,” meaning give up more sovereignty, or they face a fracture of the EU and € member nations.  Truly nothing less than a United States of Europe with the ability to issue collective debt at this point will save them.  Without that ability, the collective unit moves entirely to slow.  The recent ruling by the German high court still needs to be ratified by all 17 euro-member parliaments.

Frankly put, member nations can no longer lie about the amount of debt and abuse moral hazard if the EU and the € are to continue in its current form.  This may seem harsh, but this is the only move they have left.  Some of the debt levels in the individual nations aren’t as bad as the UK or Japan in terms of overall debt to GDP but they are viewed as vulnerable and the markets are punishing them individually.  And unless that cycle is stopped, the targets will just keep escalating from one troubled nation to the next.

About Matthew Kolesky

Matthew Kolesky is a Principal at ACM, Inc. and joined the firm in 2004. Matthew Kolesky was born and raised in Alaska and has served on many Anchorage area non-profit boards.