Keep an eye on Europe

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Keep an eye on Europe

Italy became the next country in the euro zone to teeter on the brink of a credit crisis. The country’s 10-year sovereign bond yield shot above the perilous 7-percent mark on concerns that it would backtrack from its reform measures.

The 7-percent mark has become the last warning sign ahead of default risk after Ireland, Portugal and Greece eventually had to seek bailouts when their borrowing rates jumped above the threshold. Italy’s financial troubles are the same as Greece’s. Government debt hovers at 1.9 trillion euros ($2.5 trillion) with dwindling tax revenue. Prime Minister Silvio Berlusconi and other political leaders have long lost credibility.

The European Central Bank, which has been protecting the third largest European economy, pushed Italy to the ledge by indicating it cannot go on purchasing the country’s bonds.

Italy’s plight spells a fatal crisis for the euro. Greece has been a peripheral problem while Italy, one of the six founding pillars of the European Union, can bring the entire euro zone down. Moreover with 1.9 trillion euros in public debt, the economy is also just too big to rescue.

Its bonds are largely held by French and German banks, which means if they default, it will send tsunami ripples around the global economy. European leaders are dealing with a major explosive. Italy is under immense pressure to precipitate economic reforms, and neighboring countries, unlike with the Greek crisis, would likely act quicker in trying to help the country out.

The Italian news immediately rocked the local financial market. The benchmark stock price index plunged nearly 5 percent while the dollar shot up 1.5 percent against the won.

Upon new signs of a global financial crisis, foreign investors packed up to make an exit from the Seoul bourse. Korea has no reason to be directly linked to the Italian shock.

But the economy, driven largely by external market conditions would inevitably receive a blow. Authorities would have to protect the economy and closely watch for volatility in the foreign exchange market.

Italy’s demise again demonstrates that no economy can be sustained under excess welfare spending, impotent political leadership, and low economic growth.

Politics must carefully balance welfare reforms and budget health. Jobs must be increased through liberalization and the economy must maintain vitality by expanding above its potential growth pace. Otherwise we too can follow the footstep of Greece and Italy. We must turn our eyes and ears across the Atlantic before we continue with the vain debate over our welfare system.
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