While most Americans’ eyes are on US markets, naturally, it isn’t a sure thing that the next financial crisis will be spurred by events in the United States. Sure, stock markets may be overheated and assets across a wide variety of markets are overvalued. But the US isn’t the only country with a central bank that has pumped trillions of dollars into its markets.
The European Union followed similar monetary policies in Europe, helping to prop up weak markets in the aftermath of the 2008 financial crisis. But unlike the US, Europe’s weakness had more to do with profligate spending by European governments than it did with overheated sectors such as housing. While there were some areas of Europe that suffered housing crises, Europe’s problem has largely been one of sovereign debt.
Since the introduction of the euro, less fiscally conservative European governments took advantage of the new currency regime to issue more debt. Investors began treating debt of smaller countries such as Greece almost on par with those of sound fiscal countries such as Germany. That of course was found to be a mistake, and nearly dragged Europe into financial crisis year after year. But it isn’t just small countries such as Greece that are on unsound fiscal foundations.
Italy is perhaps the largest European economy facing significant structural weakness. Its banking sector is notoriously weak, with Monte dei Paschi di Siena notably requiring a bailout from the Italian government last year. Italy’s government can’t get its act in gear either, as its debt to GDP ratio is now at 132%. And now its two largest populist parties intend to propose to the European Central Bank that the ECB forgive €250 billion in Italian government debt an renegotiate Italy’s contributions to the European budget.
That’s not a promising sign, and investors are worried that with populist political outsiders likely to shape the Italian agenda there will be a greater likelihood of a debt crisis in the near future. Italy has always been the weakest of the great European powers, both economically and politically, and it could very well end up being an Italian crisis that precipitates a broader financial crisis that becomes contagious both within Europe and around the world.