Italy is a Ponzie scheme

The Italian 10yr yield has gone to ~500bps over Germany, or ~7%. If these yields are sustained, Italy is a Ponzie scheme.

In the medium term, stable debt synamics require that the following inequality holds:

ave yield * debt-to-gdp < primary budget position + nominal-gdp-growth

If we assume that Italy is able to turn 2010's -0.3% primary position (that's the budget balance before interest costs) into a +5% primary surplus, and assume that they can get 3% nominal GDP growth (the pre-GFC trend was 4%), then given debt to GDP of ~121%, the yield at which debt is stable is ~6.6%.

At ~7% Italy is a Ponzie scheme.

The thing is that no serious person expects Italy to avoid recession in 2012. A credit crunch and a recession is baked into the cake. If there is a half decent recession, debt dynamics are going to get much more unstable, and the long term sustainable yield will fall.

Sure, they have long duration, so they can absorb a modest period of high yields, but once the market smells blood, things seldom come back. Italy needs bone grinding austerity, or it's going to go bust.

A EUR1.2tn bond market is too big to 'catch' …

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