Still No White Smoke

As serious as ongoing developments in Cyprus are ​(and they are serious, because depositors in over-leveraged European banks are now fair game, as taxpayers have been all along, if a sovereign/bank bail-out becomes necessary, say in Spain), they pale next to the threat from Italy.

Italy, the Euro-Zone's third largest economy, has been without an elected central government for a month since its national elections on February 24-25. Though President Napolitano charged Pier Luigi Bersani (leader of the leftist PD party) last week with the responsibility of forming a new ruling coalition, he cannot. Other parties, like Beppe Grillo's 5-Star Movement, want nothing to do with him (or any other part of the political establishment). Indeed, Mr. Bersani seems not just unable, but unwilling - he was quoted today as saying that only an "insane" person would want to lead Italy now. As a result, Italy's $8.8 billion bond auction Wednesday was weak, and yields on peripheral sovereign debt zipped higher. (Spanish 10-year yields rose above five percent.)

Italy's President is likely to have little choice but to call for new elections later this year, and install another technocrat (non-party) government for the interim. No "white smoke" can be expected. The issue is this - more than ever, Italy very much needs a strong, legitimate central government, to devise and implement policies for long-term fiscal re-balance, and economic structural reform. Without these, a resumption of growth, and a turnaround in the labor market, is impossible. And, in such an uncertain political and economic environment, contagion from economic emergencies in much smaller peripheral countries - like the Republic of Cyprus -  is that much more of a threat.

Watch early tomorrow morning when the Cypriot banks re-open. Bank runs and domestic turmoil in Nicosia could trigger problems in Italy, and elsewhere.