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Does Italy need a government?

In his blog, Ferruccio de Bortoli of Corriere della Sera newspaper said markets prefer an Italy without government to an Italy with a weak government. A stunning statement? Not really.

Italy has a tradition of transitional and caretaker administrations. Decades of numerous short-lived cabinets were interspersed with periods "without government" during which administrative work was carried on "as usual" without much publicity. In fact, the caretakers often made use of the opportunity of attracting little visibility to finish jobs left over from their official turn. Prime Minister Giulio Andreotti, for instance, used his caretaker role in 1973 to round up Greek political refugees in Italy and send them by plane to Athens in line with a request by the military dictatorship of the coronels who considered all Greeks hiding abroad "communists". For about two weeks no Greek refugee dared to sleep in his bed.

The example shows how powerful transitional governments can be, particularly in the absence of a functioning parliament. However, the current situation differs from the usual Italian interregnum. According to opinion polls, two in three Italians want a government to be formed as soon as possible. The maverick opposition leader Beppe Grillo refuses to comply with the wishes of the population, leaving the country in the hands of the former "technical" cabinet of Mario Monti.

Although Mr. Monti can be trusted not to do any undue things, his visibility is very low and he cannot assure the Italians that he is powerful enough to meet the current challenges. The main problem he is up to is the danger of a run on the banks in the wake of the Cypriot rescue turmoil. If Cyprus accepts the regulation that small savings accounts ( <100,000 euro) will lose close to 7 percent and larger accounts (>100,000) 10 percent of their balance, Greek and Italian bank accounts could be next in the line for a similar haircut.

Many Greeks months ago transferred their savings to Cyprus to avoid a loss; now they are furious to have been deceived. Scared by the Cypriot precedent, they might empty their residual Greek accounts and hide the cash under the mattress or book a vacation in Switzerland. While there isn't much money left in Greek banks anyway, a bank run in Italy would be pretty disastrous.

Apart from the near-bankruptcy of the Monte dei Paschi, Italian banks are not very stable. Although the European Central Bank can be trusted to provide the banks with sufficient liquidity in the case of a bank run, the psychological effect would be terrible. Already. europhobia is spreading in Italy. The common currency would be seen as an unwelcome link to a hostile northern Europe scheming to deprive Italians of their savings.

Indeed, the unfortunate truth is that a default of Italy would deprive the population of part of their savings. There are two ways the country could deal with a default: one is by abandoning the euro and reintroducing the lira, the other by staying in the eurozone and accepting an international rescue package.

Given the fact that Italy's public debt of 2,000 billion euros is the second highest after Japan's, there is no way the country could service this huge debt at the steeply increased spread — the measure of interest to be offered by the treasury at debt auctions — which would result from the loss of euro zone protection and lack of trust in the country's stability and growth. The default would thus be a direct consequence of leaving the euro zone. The devaluation of the lira vis-a-vis the euro would be anywhere between 30 and 50 percent with the possibility of some slow recovering after years of successful lira management.

Continuing poor domestic policies and irresponsible bickering among politicians in Italy could induce ratings agencies to downgrade Italian bonds to junk status and drive Italy's spread so high that default becomes as inevitable as was the case in Greece before the advent of the first bailout package of May 2010.

Several times Italy has been warned that it could not expect any European bailout in case of its defaulting. Chancellor Merkel of Germany said the sheer dimension of Italy's debt would vastly exceed any bailout potential. The president of the German Bundesbank Weidmann pointed out that the Italians would be left alone in the mess they are threatening to create by attacking the euro currency.

Similar words have been used in the case of Cyprus but in the end, a rescue package was cobbled together. Although the Italian mess is a hundred times worse than that of tiny Cyprus, the Europeans — with the help of the International Monetary Fund and perhaps even some mostly moral support of the United States — would probably try to negotiate a bailout plan to avoid the default.

As the case of Cyprus has shown to the much surprised world, the 100,000 euro savings guarantee valid in the entire euro zone has gone out of the window. If things get tough, even small savings will suffer. But in the case of Italy the reasons for this haircut would differ from the precedent of Cyprus. The small island state served for years as a haven for capitals of shady origins. Protecting these accounts at the expense of taxpayers' funds for bailout seemed unacceptable.

Although many small and large savings in Italy may also be of doubtful origin, considering the national propensity for tax evasion, there exists no internationally valid reason to punish Italian account holders. Still, Italians would not escape a haircut of their savings for a very simple reason: there is no way a bailout package of the huge dimensions required could be put together without participation of the Italian people. Probably half of the cost of the rescue effort would have to be borne by the Italian public in order to bring the overall level of the debt down to manageable levels compatible with the country's shrinking GDP.

However, there is reason to hope that the damage done by this haircut to Italian savings would be much lower than the forty percent devaluation to be expected from reintroducing the lira. It is to be hoped that Italian politicians deeply reflect about the likely consequences of the various options before them.

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—— Benedikt Brenner