In the Greek crisis, the one number to watch

By Danny Vinnik

Since Greek voters rejected the European bailout deal on Sunday, spurring talk of a European financial crisis, one of the most remarkable aspects of the past 48 hours is the lack of panic. Even though no one knows just whether Greece will remain in the eurozone, U.S. markets closed only slightly down on Monday, and even in Europe, investors appear mostly unconcerned, trusting the “firewall” that European authorities have built to contain the instability.

“It’s very hard to construct a scenario where a Greek debt crisis gets over the wall,” Mark Zandi, the chief economist at Moody’s, told POLITICO.

It’s hard to construct that scenario — but not impossible. Investors and policymakers watching to see whether the Greek crisis hurts the U.S. economy are keeping their eye on one key statistic, and it’s not in Greece: the bond yields on Italian debt.

Why Italy? The nightmare scenario in Europe is that investors lose confidence in other European countries’ ability to repay their debts, and a contagion starts to bring down other economies as well. Markets in Europe and across the globe would plummet.

In fact, these dominoes started to fall a few years ago. From 2010 to 2012, Greece was repeatedly on the brink of financial disaster as it struggled to repay its debt. At the time, Spain, Portugal and even Italy looked like the next to go.

Since then, the financial powers of Europe — the European Central Bank, the European Commission and the International Monetary Fund, known as the “Troika” — have taken a series of strong measures to contain the crisis. They’ve taken Greek debt off the balance sheets of European banks, made sure those banks were re-capitalized, and created programs to buy the sovereign debt of troubled countries. When the ECB president pledged to do “whatever it takes” to keep the eurozone together, it sent a strong calming message to investors.

This time around, Spain’s economy is on the rebound and it’s highly unlikely that investors would turn on it. Portugal is still officially in a program with the Troika that would let the ECB quickly start buying its bonds to prop it up in a crisis.

That leaves Italy, Europe’s fourth largest economy. Like Spain, it has improved in the past few years, but its debt load is far higher than Spain’s — 132.1 percent of GDP compared to 97.7 percent of GDP. Italy is also no longer officially in the European program that insulates Portugal.

“It would be a huge shock to the world and to markets in Italy to enter a program,” said Adam Posen, the president of the Peterson Institute of International Economics.

So if the yields on Italian bonds start rising, it’s a sign that investors don’t think that the firewall will hold. Suddenly, the crisis won’t be limited to Greece — and there’s no guarantee that Europe could limit it to Italy as well.

So far, the ECB’s firewall is holding strong. Yields on Italian bonds actually rose a bit on Monday, but they’re down today.

But if the firewall fails, the Greek crisis will go from a European problem to a world problem. Given Congress’s dysfunction, it’s unlikely that much would happen there — but the Federal Reserve would likely delay raising interest rates out of fear of disrupting already volatile markets. The turmoil abroad would weaken U.S. exports, costing American jobs and causing firms to cut back on investment. The economic recovery would slow or even stall out.

Economists and markets aren’t concerned about that scenario now. (“The contagion risk is medium term, but it’s not short-term,” Nicolas Vernon, a visiting fellow at the Peterson Institute for International Economics, said in an interview.) But keep your eye on bonds in Italy. If yields start rising, then it’s time to start worrying.