Imagine that your household is spending ~5% more than it takes in every year, which means that you have to keep adding that extra 5% to your credit card debt to make ends meet.And imagine that, from years of spending more than you take in, you have amassed debts that add up to ~120% of what your household takes in every year.
And imagine that your credit card company has been charging you 2%-3% annual interest to carry your debt, which has given you enough room to make your your interest payments and pay other bills without having to slash your spending too much.
And now imagine that, in the space of two months, the interest rate your credit-card company is charging you has suddenly spiked from ~3% to ~7%.
Congratulations! You’re Italy!
Six months ago, Italy was paying 2.5% to borrow money for two years.
Two months ago, Italy was paying 3.5% to borrow money for two years.
This morning, Italy was paying nearly 8% to borrow money for two years.
Like you and your credit card, in order to avoid defaulting on its debt, Italy has to keep “rolling over” the debt–borrowing new money to repay the old money. And now the cost of borrowing the new money is going through the roof.
Italy has the fourth-most debt outstanding of any country in the world–more than $2.2 trillion–trailing only the U.S., Germany, and Japan. If Italy defaults, any bank or insurance company or money-market fund or company or individual that owns its debt is going to take a big loss. Any of those companies or entities using that Italian debt as an “asset” against which it has borrowed might suddenly have to raise more capital to offset the loss. Any company that has written “derivatives” insuring Italy’s debt will suddenly have to pony up.
Balancing Italy’s budget, meanwhile, so that Italy’s borrowing costs might begin to drop again, would require massive tax hikes and/or cuts in Italy’s government spending, which would likely trigger a deep recession. And a deep recession would further reduce Italy’s government revenue, which would increase the deficit. And so on.
Meanwhile, the European Central Bank has pretty much refused to step in and rescue Italy, the way the Fed rescued US banks back in 2008. And the only country in Europe that might be able to rescue Italy–or at least stave off disaster for a while–Germany–is adamantly opposed to the idea.
So now you understand why everyone’s panicked about what’s happening in Europe.
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