Weaponized Debt Italy Doubles Down on Threat to Euro Stability

Fears are growing that the euro crisis may soon return. Italy could spark a chain reaction if it doesn't yield to the European Union's demand that it rein in its planned deficit spending. Concern is rising in Brussels and on the financial markets. By DER SPIEGEL Staff

Filippo Monteforte/ AFP

It was apparently important to him to show that it was a brand-name shoe -- quality, made in Italy. On a recent Tuesday afternoon, Angelo Ciocca, an Italian member of European Parliament, held up the sole of his shoe for all to see before trampling on the report produced by "euro idiots," this "mountain of lies" which claimed Italy's draft budget violates eurozone rules on deficit spending.

The gesture came right after Economic and Monetary Affairs Commissioner Pierre Moscovici had announced that the budget submitted by Italy must be revised within three weeks -- a rebuke that was unprecedented in the history of the European Union and a humiliation for Italy. That, at least, is how Ciocca saw it -- and he acted accordingly. He is a member of the right-wing nationalist Lega party, whose leader Matteo Salvini, as deputy prime minister in Rome, sets the tone.

In fact, this alleged humiliation plays right into the hands of Italy's new leaders. It serves to affirm their fight against Europe, against the euro and against anything that supposedly prevents their nation from being free and great.

The European Commission last week criticized the Italian government's budget, saying it "represents a clear and intentional deviation from the commitments made by Italy last July" by seeking to increase new borrowing by three times more than originally planned. But that doesn't seem to bother the boisterous Salvini in Rome any more than it does his coalition partner Luigi Di Maio of the Five Star Movement (M5S) or Prime Minister Giuseppe Conte. Since swearing fidelity on the issue at a meeting at Rome's Trattoria Sabatino early last week, the three have demonstrated their determination to stand up to the political heavyweights in Europe and to the financial markets.

'This Europe Will Be Finished'

"The lords of the spread should step aside" Salvini has demanded. Prime Minister Conte, meanwhile, says: "The more I study the draft budget, the more I like it" -- a plan which earmarks tens of billions of euros to fulfill election promises. Protests from Brussels over the budget? No problem, claims Di Maio. "This Europe will be finished in six months anyway."

He is referring to the European Parliament elections, whose May 2019 date is determining Italy's collision course, a plan which threatens to rock all of Europe, and the common currency area in particular. Lega and M5S hope to perform well enough that they can join forces with populists from other EU member states and subsequently reverse the balance of power in the EU's only elected body. Salvini recently even announced that he is considering putting himself in the running to succeed his arch-nemesis Jean-Claude Juncker as president of the European Commission, the EU's highest office.

That's why the Italian budget, together with the country's debts, represents more than just a provocation against Brussels: The Italians have turned their budget into a weapon in their fight against the hated system.

Populists from all over Europe are crossing their fingers for Salvini, including the Alternative for Germany (AfD) party. AfD co-leader Jörg Meuthen is fond of stirring up fears about the stability of the euro in Germany while celebrating the uninhibited course adopted by the Italians - the very path that could in fact cause problems for the euro. "Salvini is teaching the establishment that Italy is a sovereign state," he says.

National sovereignty is the only thing that matters, says Salvini, and the government is bound only to the people. Though that statement is less than truthful, to put it mildly.

As a member of the Euro Group, which governs the common currency, Italy agreed to submit to its rules. Previous governments in Italy signed treaties that still apply to their successors. And when the Italian government breaks these rules, it jeopardizes not only the well-being of its own country, but also that of the entire currency union.

A Monetary Policy Time Bomb

One could view this as blackmail, with the Italian government more or less threatening to destroy its own economy and take the rest of Europe down with it -- a monetary policy time bomb in the middle of the Continent.

The new government is prepared to take significant risks to finance its multi-billion-euro campaign promises, which include lowering the retirement age, a guaranteed income for the poor and lower taxes. The eurozone's third-largest economy already has debts of 2.26 trillion euros, equivalent to 132 percent of its gross domestic product. The only other country in the common currency area with a higher debt ratio is Greece. Almost 4 percent of Italy's GDP is now being used to service its debt load -- a trend that is growing as it becomes more expensive for Italy to borrow fresh money on capital markets.

The spread on 10-year Italian government bonds compared to their German equivalent, also known as the risk premium, is akin to a thermometer showing Italy's health. And the patient's temperature is rising. Having more than doubled since mid-May, the risk premium now stands at over three percentage points. When it reaches four percentage points, the symptoms of the crisis will begin to intensify. That is when the first banks will begin to experience liquidity problems.

Are Italy and Europe on the brink of a banking crisis? And if so, will that crisis come with the risk of contagion that could then spread from Italy across the Continent to Greek, French and ultimately to German banks?

European bank regulators plan to reveal the results of this year's stress test on Friday, and institutions with an above-average share of Italian government securities on their books are under closer scrutiny this time. Italy's financial institutions have already begun the process of passing on the increased risks to customers in the form of more expensive loans, but that news doesn't yet seem to have become common knowledge in the country. Almost 60 percent of Italians surveyed in public opinion polls say they support their government's hazardous gamble.

A Game of Chicken

It's a bet with an uncertain outcome -- like a game of chicken. Who will lose their nerves first: the Italians, Brussels or the financial markets?

If the Italians swerve, they will embarrass themselves in front of their own voters. So far, there is no indication of that happening, but this could change if spreads continue to rise.

Or will Brussels swerve? If that were to happen, the Euro Group would lose more authority, with the danger that other countries would buck the rules as well. But even if Brussels were to come up with a wishy-washy compromise, that would require the Italians to first budge at least a little so that both sides could save face.

And if both sides dig in? In the end, there could only be losers. If spreads continue to rise, the risk of bank failures in Italy will grow, and the entire country might face bankruptcy or a withdrawal from the currency union. And an "Italexit" would have devastating consequences -- not only for the country itself, but also for economies across the eurozone.

Graphic: Sovereign debt loads of eurozone member states
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Graphic: Sovereign debt loads of eurozone member states

So far, financial markets have been reacting with relative calm, but the nervousness is growing. And, with it, the fear of a crash. Last week, Germany's blue chip stock index, the DAX, fell to its lowest level in two years. The threat of hard Brexit, the trade war launched by U.S. President Donald Trump and now also the danger of a new euro crisis: Taken together, it is an explosive mixture.

The situation is reminiscent of the first euro crisis at the beginning of the decade, which was triggered by Greece's escalating public debt. Speculators fired away at the country and eventually targeted other crisis-ridden eurozone countries. The risk premiums for government bonds reached perilous heights, and many countries were no longer able to finance themselves. The Euro Group had to create a bailout fund to save Greece, Ireland, Cyprus, Spain and Portugal.

Deceptive Calm

Calm didn't return until Mario Draghi, the head of the European Central Bank (ECB), flooded the markets with money and started buying up bonds from the crisis countries. He promised to defend the euro by all means -- or, as he put it, with "whatever it takes." Ultimately, the speculators gave up and the investors returned.

But it was a deceptive calm. Little has changed when it comes to the underlying problems within the eurozone. Not all the crisis states used the time Draghi bought for them to undertake urgently needed reforms. Eurozone member states also failed to undertake the joint reform of the currency union, which would have involved redressing imbalances or adopting shared economic and fiscal policies. France issued a list of proposals, but the Germans proved more adept at talking about why the French ideas wouldn't work than formulating any of their own.

That's why Italy's attack is now hitting Europe with such force. The euro crisis never really went away, it was just obscured by the ECB's cheap trillions. Indeed, the crisis could come back at any time if financial markets lose confidence, if investors retreat or if speculators start betting against individual countries. And, as such, against the euro.

All this because a country like Italy doesn't follow the rules.

But there is one decisive difference to the euro crisis of the early 2010s this time around: Brussels and the ECB can only come to the aid of countries that at least pretend to abide by the rules. Conte, Salvini and Di Maio are openly flouting them. They don't even seem capable of producing a half-way credible masquerade, must less any kind of serious fiscal strategy.

Revolution or Ruin?

Nervous? Not at all, says Prime Minister Conte. He affably talks about his emotional state, a glass of water in front of him and hours of haggling with his coalition partners behind him. On this morning, the slender man with the hoarse voice -- a man his two rivaling deputy prime ministers regard as little more than a buffer -- has brought along his spokesman and minder. This is the same man who, in a wiretapped call, said decision-makers in the Finance Ministry, the "little pieces of shit," who didn't toe the new government's line, could be easily dispensed with if they knuckle under.

Conte himself wouldn't express things in such drastic terms himself. He speaks of a "loving revolution" that is currently unfolding in Rome and says there is no "gang of hotheads" at work under his leadership. However, given that "this Europe has not succeeded in fulfilling the dreams of its people," radical changes are needed. And those who criticize Italy's course -- the normally cordial Conte raises his voice as he utters these words -- are in for a surprise. "Within a few weeks, Italy will be revolutionized," he says.

Graphic: Budget deficit/surplus forecasts for eurozone member states
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Graphic: Budget deficit/surplus forecasts for eurozone member states

Or ruined. At least according to skeptics. They don't believe that the planned extra spending, contrary to Rome's promises, will boost growth to the extent that it can help shrink the country's mountain of debt. They think it will just exacerbate the problems.

"The biggest problem from an economic standpoint is that the money we have to borrow is then distributed to pensioners and the unemployed and not invested productively," says Andrea Ichino, an economics professor at the European University Institute in Florence. "Italy is an old country, and the elderly don't look any further ahead than 10 to 15 years. They are not concerned that their children will have to repay these debts someday."

The rating agencies currently only rate Italian bonds at just above junk level. A further downgrade would mean that even the European Central Bank, which has been the most active backer of the debt-financed Italian budget, would no longer be permitted to buy up Rome's bonds. In August alone, foreign investors sold off 17.4 billion euros worth of Italian sovereign bonds -- an indication of their growing lack of confidence. At the same time, Italian banks bought additional government bonds, though reportedly not always voluntarily.

But the government's contrivance is less related to economics than politics, and, more specifically, party politics.

Even though the companies listed on the stock exchange in Milan have shed one-fifth of their value within the last six months, the two government parties are still soaring in the polls. Lega, at 30 percent, is polling at twice as high as its result in the March election, and the Five Star Movement is hot on its heels.

Is Rome aiming to leave the common currency behind? Or even the European Union? No, says Prime Minister Conte. Not really, say Salvini and Di Maio. And yet they continue skipping down the path toward ruin.

Italy may not be aiming to leave the EU. After all, "the government has made it clear that our membership in the EU and the eurozone is beyond question," says Vincenzo Boccia, president of the General Confederation of Italian Industry. But he also warns that the government's growth forecasts are optimistic, the investment plans "hazy" and that the risk of its policies negative affecting families and businesses are significant. "If public debt rises faster than GDP, then all Italians will get stuck footing the bill," warns Boccia. "Those in government are also responsible for ensuring that their policies are economically viable for the country."

Alessio Rossi, president of the Association of Young Italian Entrepreneurs, is even clearer. "We are at risk of turning our future into a junk bond," he says.

Structural Problems

Those who argue that Italy needs to boost the purchasing power of its people at the expense of future generations to trigger an economic upswing are overlooking the country's significant structural deficits. The recession that began in 2008 left wounds that still haven't healed and last year's GDP was still lower than it was in 2007. The poverty rate has almost doubled since the outbreak of the crisis, and unemployment is falling only slowly.

The reforms initiated by Matteo Renzi during his term as prime minister with the Democratic Party, including the liberalization of the labor market, had little time to take effect, and Renzi was out of power less than three years after taking office. Some of those reforms are now being reversed. Among other things, the retirement age is to be lowered, a significant cost factor in the country with the second highest life expectancy on the Continent.

The tax burden in Italy is also still among the highest in Europe. Small and medium-sized businesses, the backbone of the high-tech economy, particularly in the north of the country, have problems obtaining credit. And the judiciary works at a snail's pace. On average, five years elapse before judgments are typically reached, with a backlog of millions of cases. For investors valuing legal certainty, that is a major turn-off.

Worse yet is the comparably low productivity of Italian companies, which hasn't grown since the end of the last millennium. Over that same period, productivity increased by more than a quarter at German, Spanish and Portuguese companies.

One man who ought to know what it feels like to be at the top of his class is sitting in a tiny Umbrian village with a medieval center. "It is often said that we Italians are the world champions of dealing with the unpredictable," he explains. "I am proud of my people, of Europe, but a little German order wouldn't hurt us either."

Billionaire Brunello Cucinelli made his fortune in high-fashion cashmere apparel and has also spent a lot of time thinking about his fellow compatriots' talents and shortcomings. He says Italy would be well-advised at the moment to listen a little more closely to outside voices, "to the International Monetary Fund, to my esteemed friend Mario Draghi and to the EU in Brussels."

Cucinelli says that in his 65 years of life, 60 Italian governments have come and gone, and not a single one of them has survived until the end of its legislature period. "Italians fall in and back out of love very quickly when it comes to politicians," he says. Cucinelli, whose cashmere sweaters cost up to 2,000 euros each and are popular the world over, considers himself to be "staunchly pro-European" and says he can only advise his fellow Italians to take a similar view. He says Italy can look forward to "a wonderful future" in tandem with Europe.

Record Disapproval of the EU

These days, though, Cucinelli is in the minority with that opinion. Viewed from afar, the love between Italy and the European Union has lost its spark. Whereas Italians were among the EU's strongest supporters before joining the common currency, they are now at the bottom end of the spectrum. According to the Eurobarometer polls conducted by the European Commission, only 44 percent of the country's citizens still support membership in the EU, a historic low for Italy. In the land of Altiero Spinelli and Alcide de Gasperi, who were among the EU's founding fathers, and the land where the Treaties of Rome, the birth certificate of a united Europe, were signed, the prevailing opinion now is that the European confederation of nations is responsible for Italy's current decline.

And its aggressively eloquent and polemical Interior Minister Salvini is happy to tirelessly pour oil on the fire. He says the European Commission's letter to Rome warning about its budget is not only an attack against the government, but also one against "a people." Salvini has pledged that if the European Freedom Front, with himself and French right-wing populist Marine Le Pen at the helm, emerges victorious from the European Parliament election in May, they will place the rights of individual countries back at the center of European politics.

'Sticking Their Tongues Out at Us'

The pan-European right-wing movement might be part of the reason why the rest of the eurozone remains undivided this time around. No eurozone finance ministers have moved to support the Italians. And in contrast to the Greek crisis, no government appears to harbor secret sympathies for the rebels.

We are confronted with an "unprecedented situation," EU Monetary Commissioner Moscovici said last Tuesday. "We are not confronted with a borderline case; we are confronted with a deviation which is clear."

On that point, it is hard to argue. The Italian budget plan doesn't just slightly deviate from the previously agreed framework. It is more like its exact antipode. Instead of a budget deficit of 0.8 percent for 2019, the Italians are now planning 2.4 percent. And although that figure is still below the 3-percent deficit spending limit stipulated in the Maastricht Treaty, it is three times higher than previously planned.

Graphic: The worst-case scenario
DER SPIEGEL

Graphic: The worst-case scenario

The main problem with deficit spending of 2.4 percent is that the money won't be going toward the financing of reforms, says Günther Oettinger, Germany's EU commissioner. Instead, the country is rolling them back. "The mix isn't right, and Italy will suffer as a desirable place to do business as a result."

Markus Ferber, who is responsible for economic policies for the conservative Christian Social Union (CSU) party in European Parliament, sums up the mood tersely. "The Italians are sticking their tongues out at us."

The situation currently developing in Italy -- in which a eurozone member state is flouting budgetary discipline at the expense of the others -- is exactly what the common currency area wanted to avoid when it adopted the European Fiscal Pact in response to the euro crisis in 2012. That pact gave the European Commission the power to reject a eurozone member state's draft budget and demand improvements. Its idea was to prevent excessive budget deficits from the outset rather than punishing a country after it was too late. It all sounded wonderful at the time. But apparently nobody foresaw having to deal with a person as audacious as Salvini.

If Rome doesn't comply, and if a so-called "excessive deficit procedure" becomes inevitable, Italy could be faced with sanctions like fines or the suspension of EU subsidies. But such steps would require the approval of EU finance ministers, which could prove tricky given that EU countries generally have little interest in punishing fellow member states. Such sanctions have never been imposed.

And it's unlikely to be any different this time around. The Commission, after all, is in a catch-22. On the one hand, it can't simply stand passively by and watch what is happening in Rome. It has to remain firm. On the other hand, doing so plays directly into the hands of people like Lega boss Salvini and his campaign against Brussels.

The situation is particularly tricky because the standard motivations apparently no longer work. The EU's deficit procedure is aimed at helping repentant sinners back to the path of virtue. But if there's one thing that the powerful men surrounding Lega boss Salvini are not, it's rueful. The opposite its true: They seem to want to fuel the conflict with Brussels rather than solve it.

Dealing with a Stubborn Child

But how do you raise a stubborn child who finds punishment encouraging? With yet more punishment or with indulgence? Or should one simply trust that the pressure for change will come from elsewhere?

"A letter of warning (from the European Commission) will do nothing to change this Italian government," says European parliamentarian Ferber. "We'll have to rely on the markets to bring the government to its senses."

Indulgence is not an option for the European Commission. But consistency hasn't always been the EU's strong suit either. The French have also announced that they will allow higher deficit spending next year of 2.8 percent. "That doesn't make the issue with the Italians any easier for us," says a top German civil servant.

Furthermore, the fact that the European Commission frittered away its credibility as the guardian of the Stability and Growth Pact in the past is also coming back to haunt it. Commission President Juncker, in particular, was too lenient in his approach to the Italians -- in part, ironically, to try to keep the populists from coming to power in the first place.

Over the past three years, the Commission has repeatedly turned a blind eye to Italy's budget. At times earthquakes or other natural disasters in the country prompted the leniency toward Rome. Other times it was cut some slack because of the number of refugees arriving on its shores, or the Commission wanted to give Italy the help it needed to undertake structural reforms. The European Fiscal Board, which has an advisory capacity, recently criticized the Commission's lax approach to Italy.

At the EU summit on Oct. 18, the majority of EU leader preferred to avoid this sensitive issue. German Chancellor Angela Merkel met with Prime Minister Conte on the sidelines, and as the Italian shared afterward, the chancellor had been very impressed by the structural reforms his government was planning, by the fight against corruption, for example, and by the digitization of the public service sector. What Conte didn't convey, however, is what Merkel told him about his government's budget plans.

To make matters worse, no one in Brussels has a strong connection to the true leaders in Italy, the coalition partners Salvini and Di Maio. "I am not the interior minister of Europe," says Commission President Juncker. He says his point of contact is the Italian prime minister, not the interior minister. "We will ask more questions in the coming days, but I will also meet with Mr. Conte in the coming weeks. We're keeping in touch."

Juncker says he's "worried about the anti-European sentiment some people are building up in Italy out of domestic political considerations, but I can't change it." Juncker says he grew up in Luxembourg alongside Italian immigrant workers and their children. "I won't let anyone destroy my love for Italy, not even Mr. Salvini."

The most prominent Italian in the European institutions, Mario Draghi, is also playing a special role in the drama. Especially in Germany, suspicions often circulate that the ECB head is conducting monetary policy in the interests of his fellow compatriots. With his debt policies, Draghi has managed to protect the currency area from spiraling into deflation while also stimulating the economy. In doing so, he also bought time for his home country to recover economically.

But the populists are now rewriting the happy story of the ECB president who saved the eurozone. And, as a result, the otherwise so impassive Draghi has been showing his nerves recently. He's fighting for his legacy, after all. In November 2019, he will have to turn his office over to an as-yet-unnamed successor.

A Country Mutates into a Pariah

Draghi is an Italian patriot through and through. He rarely spends more than two or three days in Frankfurt at a time, preferring to spend time with his wife Maria in Rome, where he is witnessing firsthand how his home country is mutating into a European pariah.

At this year's annual meeting of the International Monetary Fund (IMF) in Bali, Draghi was unusually forthright. He called on Italian politicians to stop questioning the euro, adding that "these statements have already caused real damage."

In an early October phone call with Italian President Sergio Mattarella, he explained the risks of the runaway national debt growth. Later, he even visited Mattarella personally at his official residence, Rome's Quirinal Palace, even though it is highly unusual for central bankers to approach politicians so directly.

Draghi also maintains close contact with Economics and Finance Minister Giovanni Tria, though neither Salvini nor Di Maio take the cabinet member particularly seriously. They view Draghi as nothing more than a representative of the hated establishment.

In Germany, which is home to some of his most vocal critics, Draghi is accused of being too indulgent with his home country. The main focus is on the Outright Money Transactions (OMT) program that Draghi first presented to a bewildered public in August 2012, a kind of super lifeline for crisis-plagued eurozone members. The program allows the ECB to buy up unlimited government bonds of countries that have been cut off from the capital markets, provided they adhere to strict budgetary discipline.

So far, no country has yet applied for OMT aid, but the announcement alone reassured investors. The ECB has also been buying up government and corporate bonds from all eurozone countries since 2015, which has achieved the desired effect. The value of bonds has risen and interest rates on them have fallen. For years now, governments and companies alike have been able to obtain fresh money at considerably more favorable interest rates than would have been possible without the aid measures.

Bond Buying To End Soon

In the future, however, the ECB will have few opportunities to take active countermeasures, because the bond-buying program terminates at the end of this year. At the start of 2018, the ECB already halved the program's volume to 30 billion euros a month in order to initiate a return to monetary policy normalcy.

As much as 17 percent of the purchase volume of what has since grown to more than 2 trillion euros spent during the program were used to buy securities of Italian origin. That proportion corresponds to the capital share Italy's central bank, Banca d'Italia, holds in the ECB. The CSU's Ferber already fears that the Italian crisis could scupper the planned exit from the ECB's bond purchasing programs and the end of the low interest rate policy tied to it. "Ultimately, Germans with any savings are suffering under the Italian debt policy," he says.

Even if the announced end of the bond buy-up program does come to pass, the Italians (and the entire eurozone) won't be totally without ECB protection come 2019. The ECB wants to keep its key interest rates at zero percent until at least the summer. And maturing bonds held by the ECB are to be replaced for an extended period through the purchase of new securities. This would provide ample liquidity to commercial banks, in particular.

But interest rates on Italian debt securities are likely to continue rising significantly from 2019 onward in light of Rome's debt policy.

It wasn't all that long ago that Italy had seemed to be on the right track under its previous government. Excluding debt that, for the most part, had been accumulated long ago, Italy's budget has had a primary surplus for years. The relatively solid budget policies of the previous governments were also well-received by the markets. The ECB's crisis policy also ensured that the average interest rate on Italy's immense public debt fell.

An added factor is the sometimes irrational enthusiasm Italians have for their country's sovereign bonds. When the Finance Ministry offers BTP Italia bonds, hundreds of thousands of people regularly purchase them. Two-thirds of all Italian bonds, or well over a trillion euros, are held by Italian banks, insurers, small savers and Banca d'Italia, a high level compared to other countries internationally.

'Completely Irresponsible'

Foreigners, on the other hand, are increasingly retreating from the market. Jörg Krämer, chief economist at Germany's Commerzbank, speaks of a "completely irresponsible budget policy." He says the assumptions for the economic growth that were used as the basis of the draft budget the government submitted are exaggerated and that new debt in 2019 is therefore likely to be significantly higher than the estimated 2.4 percent.

He warns that if Brussels agrees to a half-baked compromise, it could send a disastrous signal to other states in need of structural reforms in the eurozone that they can loosen the reins on those efforts. For example, the new minority government in Spain, led by the Socialist Party, wants to raise the minimum wage by more than 20 percent to 900 euros a month with the support of the left-wing protest party Podemos. "Where is that going to end?" asks Krämer.

At the ECB, officials are secretly hoping the capital markets will have a disciplining effect. But the higher the interest rates on Italian debts rise, the more likely the government in Rome is to blame the ECB. "This is a win-win situation for Salvini," says economics professor Ichino of Florence. Either the EU will meet him at the halfway point, he says, or it will remain firm. If it does, then it will provide an easy bogeyman for Salvini. "If Salvini gets more than 40 percent in the European elections, he will immediately seek snap elections in Italy to win the absolute majority in parliament."

But the economic problems would remain. Rome needs around 250 billion euros in fresh money each year, and Italy's government bond market is one of the largest in the world. "If interest rates continue to rise, the situation will grow increasingly precarious," says Andrew Bosomworth, Germany Investment Manager at Allianz subsidiary Pimco, the world's largest bond trader.

The rise in interest rates is also problematic for Italy's banks because they would ultimately have to write off some of the government bonds they hold in their balance sheets if those securities lose part of their value. That happens automatically when interest rates rise. Every value adjustment also has the effect of reducing the banks' equity capital, a vicious cycle.

Things will get particularly gloomy if the rating agencies continue to lower Italy's ratings, because every downgrade invariably causes interest rates to rise further given the increasing risks that Italian bonds carry. And if credit ratings fall to junk levels, the world's major funds would have to dump their holdings of Italian bonds back onto the market. Then there would be no stopping things, and a national bankruptcy would suddenly become a realistic scenario along with Italy's potential withdrawal from the common currency.

And yet, or perhaps therefore, there are few people in positions of power willing to talk about this danger -- and many who are seeking to play down the possibility. "The ice is thin," says one person with intimate knowledge of the financial markets. "Nobody wants to spark a panic with alarmist remarks." Any thoughtless statement could tempt Italian savings account holders to clear their accounts and investors to unload their Italian government bonds.

'Italy Is Not Greece'

On Oct. 23, Klaus Regling, the head of the euro bailout fund known as the European Stability Mechanism, made an effort to avoid the impression there is any panic over the situation in Italy. It's his agency, after all, that would be called upon to act if Italy really did slide toward the abyss. It's also quite possible it would be a bigger strain than the ESM could handle.

"Italy is not Greece," says Regling, before uttering number after number after number to support his argument. Italy, and this is his point, is a long way away from needing help from the euro rescue fund. Italy has its strengths, the financial expert says, pointing to the primary surplus and the country's high savings ratio.

Regling also isn't particularly worried about any risk of contagion for the other euro countries. "We are much better prepared than we were 10 years ago," he says. Officials at the German Finance Ministry also note that former crisis countries such as Cyprus, Ireland and Portugal have done their homework, and even Greece is in a better position today.

German Finance Minister Olaf Scholz is also making every possible effort to present the new turbulence and quarrels as a purely Italian matter. His hope is that, once the right-right populist government in Rome recognizes that the others will not allow themselves to be blackmailed, it will reverse course.

Yet despite all the efforts at reassurance, "the situation is much more fragile than the Italian government thinks," says Guntram Wolff, head of the respected Brussels think tank Bruegel. "If Italy ever gets to the point where Greece was in summer 2015, it will be more than we can handle."

That summer, the euro crisis flared up once again. Greece's new prime minister at the time, Alexis Tsipras of the left-wing party Syriza, and Finance Minister Yanis Varoufakis were refusing to abide by the agreed-to rules. They instead demanded that Brussels provide debt relief and loosen the reform and austerity conditions their country had to fulfill in exchange for the aid programs. They were met with fierce resistance. Germany's finance minister at the time, Wolfgang Schäuble (who famously said, "It's over") even pleaded for Greece's departure from the monetary union.

'Crystal-Clear Risk'

But while Europe's economy certainly could have absorbed "Grexit," an Italexit would be a completely different story. Clemens Fuest, the head of the Munich-based economic research institute ifo, says that with an economy 10 times larger than Greece's, Italy is "systemic." It could destabilize the entire financial system.

Fuest argues that Europe must arm itself against this "crystal-clear risk" and dismantle financial relations with Italy. Eurozone banks would have to sell the country's government bonds and cancel Italian loans. On the one hand, that would reduce their susceptibility to blackmail and on the other hand, he says, it would serve to intensify market pressure on Italy.

At the same time, however, he advises not only to negotiate with the Italian government over the level of debt, but also to discuss possibilities for cooperation. So far, though, both sides have shown little willingness to engage in such negotiations.

In Greece, Tsipras finally relented in the summer of 2015, but only just before reaching the cliff to Grexit.

By Tim Bartz, Armin Mahler, Walter Mayr, Peter Müller and Christian Reiermann

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