Rescue of Italy Will Spark Global Uprising

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Matthew Lynn's London Eye Archives | Email alerts

Nov. 30, 2011, 12:01 a.m. EST

By Matthew Lynn

LONDON (MarketWatch) "� Soviet Russia didn't produce much of enduring value. No one drove its cars, or flew in its planes if they could possibly avoid it. But it did have a good line in cynical world-weary humor.

Among the many jokes that circulated in the country was one that went like this: Every philosophy is like looking for a black cat in a dark room; Marxist philosophy is like looking for a black cat in a dark room, but the cat isn't there; Soviet philosophy is like looking for a black cat in a dark room, the cat isn't there, but you keep shouting "I've found it! I've found it!"?

There was strong demand for Italian bonds, but Italy still faces enormous hurdles with new highs on bond yields, Charles Forelle reports on Markets Hub. Photo: AFP / Getty Images.

The search for a solution to the euro zone crisis is starting to sound very similar "� and might soon start to develop its own brand of morose gags. Every week we get another big search for a smart-sounding scheme to rescue the project. Every week, officials proclaim they have found it "� when, of course, they haven't really.

The latest wheeze? Getting the International Monetary Fund to bail out Italy.

Italian borrowing costs have now broken decisively through the 7% barrier. At an auction on Monday, the country had to pay 7.3% to get away a small bond issue of 567 million euros maturing in 2023. A year earlier it paid just 2.9% on bonds of similar duration. If my borrowing costs tripled in a year, I'd be broke. There is no reason to think that Italy "� with one of the highest government debt-to-GDP ratios in the developed world "� can survive either.

In effect, the country is being locked out of the credit markets. That is bad news for just about anyone, whether a government, corporation or individual. For a nation such as Italy with a big budget and trade deficit to fund it is catastrophic.

Now, however, there are reports that the IMF will come to the rescue. The Fund last week announced a newfangled piece of financial engineering called the Precautionary and Liquidity Line. No doubt, those Soviet humorists would have had fun with that piece of bureaucratic newspeak "� the Reckless and Broke Line might be a better name for it.

But whatever it is called, it is not going to work. Why not? Because it puts too much financial strain on the rest of the world. Indeed, if the IMF goes ahead with the plan, it might well finish itself off as a serious custodian of the world's financial stability.

Technically, the IMF might be able to pull it off. Under the Precautionary and Liquidity Line, which allows a county to borrow via the IMF based on its quotas to the Fund. Italy could receive as much as 333 billion euros of financial assistance over a two year period. Italy is going to have to borrow 461 billion euros over 2012 and 2013 "� slightly more than the GDP of Switzerland, which is why everyone is getting so nervous "� so the IMF would be covering 72% of that.

The European Financial Stability Facility, assuming it manages to tap the Chileans or the Nigerians or who ever it is asking for money this week, should just about be able to cover the rest.

To a corporate financier doodling on a spreadsheet, it might just work. In the real world it doesn't have a chance.

According to calculations by the London office of the investment bank Daiwa, that amount of money would consume 64% of the IMF's available resources. But Italy contributes just 3.1% of the IMF's money. So just to get this clear, a country that chips in 3% of the money in the pot gets to take out 64% at the other end, roughly 20 times what it put in. Does that strike you as fair?

Next, pause to think about some of the countries that are making the contributions.

Many of them are significantly poorer than Italy. According to the World Bank, Italy has a GDP per capita of slightly under $34,000. China contributes 6% of the IMF's funding, but it has a GDP per capita of $4,393. India and Russia contribute 2.3% each, but they have GDP's per capita of $1,447 and $10,440 respectively. Indonesia is nobody's idea of a wealthy country (its GDP per capita is $2,946) but it pays 1% of the IMF funds so it will be subsidizing a country more than 10 times richer.

True, some countries might be in a better position to afford it "� the U.S. for example, which contributes 17% of the IMF's total funds. Its GDP per capita is $47,184, so it is a fair bit richer than Italy. But does it really want to dip into its pockets to rescue what is a perfectly well-off nation at a time when it has massive debts of its own to deal with? It doesn't sound like a policy you would want to have to defend going into a presidential election year.

In truth, complex financial engineering involving the IMF is the last thing the global financial system needs this year. The poor bailing out the rich is immoral; it should, after all, be the other way around. Worse, it is also completely unsustainable. Very quickly, the poorer countries are going to take their money off the table "� and who could blame them?

Likewise, the richer countries. Of the top five contributors to the IMF, the U.S. and Britain will struggle to get it through their legislators. Japan probably can't be relied upon either. So any money used to guarantee Italy will be constantly in the balance, dependent on reluctant electors withdrawing their support.

If the IMF pushes ahead with the scheme, the entire organization could collapse amid a rolling wave of protests. That would be tragedy. If ever the global financial system needed a body to promote cooperation and stability, it is now.

The dilemma in the euro zone remains the same as it has been for months. Either Germany pays for the bailout, or the thing gets broken up. Everything else is just shouting that you've found a black cat in a dark room "� when, of course, it isn't there.

Matthew Lynn is chief executive of Strategy Economics, a London-based consultancy. His most recent book is "Bust: Greece, The Euro and The Sovereign Debt Crisis"? published by Wiley.

Matthew Lynn is a financial journalist based in London. He is the author of "Bust: Greece, the Euro and the Sovereign Debt Crisis," and he writes adventure thrillers under the name Matt Lynn.

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