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The Stalemate in Italy Could Destabilize Europe

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With the announcement that the attempts by the Democrats to form a government have been derailed by what the Economist characterizes as two clowns, former Prime Minister Silvio Berlusconi and Beppe Grillo, the situation in Italy gets more dangerous.

With an indebtedness of 2 trillion euros ($2.50 trillion) or 125 percent of its GDP, Italy is the most fragile European country. Furthermore, the Government of Mario Monti resorted to the cheap solution of borrowing shorter, decreasing the average life of the Italian debt by one year. This year alone, Italy will need to find 400 billion euros. The last auction did not meet the success it was hoping for and the highes spread with the German Bunds. Italy is on the brink. In Ancient Rome, it was described as the Tarpeian Rock in Rome. The liquidity is gradually moving North. Germany's two year treasuries have a negative interest rate. The current 10-year yield of Italy is at 4.77 percent, an increase of 20 percent since the end of 2012.

In a post-Cyprus environment, or, as the Institute of International Finance puts it in this week's Euro Briefing, in a Post Solidarity Era, fears are increasing.

The movement from the South to the North of Europe is extremely perilous. It will be further accelerated by the incomprehensible decision to tax deposits above 100,000 euros, that could lead to a run on Italian Banks with large deposits going to banks in sounder countries than Italy. This might force the European Central bank to intervene, but its means are limited with a 3 trillion euros ($3.75 trillion balance sheet). The first candidate for a run on the bank is Monte dei Paschi who had to be rescued by the Italian Treasury and announced a 3 billion euro loss in 2012, Europe has played with fire in the Cyprus crisis. The king is naked. By transferring its responsibility to depositors, it has planted the seed of a major crisis. Already today, Slovenia seems to be in difficulty and could well be the next Cyprus.

More than ever, caution and wisdom are needed. Europe has displayed neither of them, neither did the International Monetary Fund who needed to defend its Managing Director, Christine Lagarde, who is in difficulty in a French inquiry for abuse of power that was well-known before her appointment. The IMF has no place in the solution of tiny problems such as Cyprus. The Eurozone needs to assume its responsibilities.

Nothing is simple in Europe, but complexity is not an excuse for complacency.