Here we go again

Tomorrow, the Italian parliament holds a confidence vote on embattled Prime Minister Silvio Berlusconi. Given the divisions on both the governing and opposition sides of Italian politics, there is a good chance this vote will usher in a period of political instability in the country.

Normally, Europe expects to be entertained by Italian politicians, a gallery that has, in the past, involved a wide assortment of scholars, strippers and crooks. However, given the current febrile state of Europe's financial markets, a period of uncertainty in what is seen as one of the continent's weak links will not be welcomed.

After Greece, came Ireland's turn to be bailed out by its European Union partners. Meanwhile, against its better judgement, the European central bank is buying government bonds to ward off a speculative attack on the next domino. It is widely expected that if another country is to suffer a run on its bonds, it is likely to be Portugal, Spain or possibly Italy.

Of the three, the least likely is Italy because its finances are comparatively sound. However, that is due to the work of a prudent finance minister. His position would suddenly come into question were Berlusconi to fall. And it does appear that speculators are eager to turn on the next European country to fall.

No real mechanism

Perhaps with good reason. Despite their assurances that they will do all they can to crush a speculative attack on any of its members, the European Union has no real mechanism for doing so. It relies on member states to agree to a process, and then commit the resources needed. And member states are divided.

Germany wants to take a hard line, with Chancellor Angela Merkel apparently even threatening to pull out of the euro if governments that receive assistance do not take sufficiently bitter medicine. However, many countries are acting as if bailouts will prevent Europe having to deal with its long-term financial problems.

True, countries like Greece, Ireland and Spain have engaged in swingeing budget cuts. But that may not be the point. They are, arguably, addressing a long-term problem with short-term pain - and in the process, possibly exacerbating the problem. It is not yet clear that European countries are prepared to confront the long-term, structural challenges they have in the tension between an ageing population that demands more services, and an economy that is in (relative) long-term decline. Sooner or later, the crunch will come. And it appears now to be so close, the first rumblings have started.

If another contagion broke out in Europe, it is not obvious that the ocean separating Europe from North America would prevent the waves going further west. Some US states' finances are in a dire condition. The federal stimulus programmes bought states some time to shore up their finances, but with this programme running its course, some very difficult decisions loom.

'Purchased' sins

Markets would be soothed by reassurances that governments are planning to tackle their debt problems. So far, the messages have not inspired confidence. The recent extension of federal tax cuts, which will further worsen the US deficit, drove US bond yields sharply higher. Meanwhile, a recent Bloomberg poll found that most Americans want the debt reduced only if there are no cuts in Medicaid, Medicare, Social Security, defence spending, farm subsidies and most domestic programmes. There's unanimous agreement that paper-clip purchases can be slashed mercilessly, though.

The Western world's financial markets remain on edge, and could be set off into another panic at a moment's notice. Should Italy's government fall, bond traders might turn their sights on Portuguese bonds, widely seen as the most vulnerable to a speculative attack. If a run on Portugal starts, Spain - whose banks are heavily invested in Portuguese bonds - could come next.

Watching from the sidelines will be traders in New York and Chicago, who are already showing their anxiety about the US's finances. If anyone thought rescuing a couple of bankers ended the financial crisis, he may soon be in for a rude awakening. Government took upon themselves the sins of the banks. Soon, they will suffer for them.

John Rapley is president of the Caribbean Policy Research Institute, an independent research think tank affiliated with the University of the West Indies, Mona. Feedback may be sent to columns@gleanerjm.com.