Berlusconi Cuts Deal: Et Tu, Brute

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

By Marc Chandler

NEW YORK ( BBH FX Strategy) -- Controversial Italian Prime Minister Silvio Berlusconi appears to have finally capitulated to international and domestic pressure.

Press reports indicate that he has agreed to step down by January, making elections likely by March. That's one year earlier than Berlusconi had previously insisted.

Italy would join a number of other countries expected to have elections or change leadership in other ways. This includes the U.S., France, Mexico, China and Russia. Spain's election initially penciled in for next year has been brought forward to next month. It is possible that the current Greek government collapses, especially if a supermajority is required for passage of reforms that emerge from the EU summit.

It is clear that if one wants the great experiment of monetary union without political union the contagion cannot really reach Italy.

Its stock of debt is such that a modest increase of rates in the primary market (new issuance) is not as ruinous as it may be for lower-debt countries in terms of average yield and increases in the secondary market.

Increases in yields in the secondary market affect other market participants and sentiment.

News that the end of Berlusconi's government is around the corner does not appear to have generated much market reaction. The sovereign credit-default swap is essentially flat on the day.

The generic 10-year yield is also essentially unchanged, at a little less than 6%. Italian equities are higher. Italy's Treasury sold 10.5 billion euros of bills and bonds Wednesday. Short-term yields are at their highest levels in nearly 3 years.

Berlusconi and his ally/rival Umberto Bossi of the Northern League have agreed to send a letter of commitment to the EU before Wednesday's summit (though reports suggest no one has received it yet) to raise the retirement age to 67 and other structural reforms. Bossi had as recently as early this week rejected raising the retirement age.

The risk is that conventional opinion blames Berlusconi for more than is his due. Unlike many countries, for example, that have surges in the deficits, the Italian budget deficit is not the main problem. It is Italy's debt, an accumulation of past deficits. It is more a legacy problem. But ultimately even this is only the third of the iceberg that is above the water. The real problem in Italy and other peripheral countries is simply the lack growth and competitiveness.

The opposition to Berlusconi could not bring the government down through numerous confidence votes. Ultimately it was his own coalition that brought him down. As we have seen in countries in the eurozone that have had elections, like Ireland and Portugal, the opposition offers different personalities but not a different program.

How to rekindle growth in Italy does not seem to be understood, and investors cannot really be confident that raising retirement ages and making it easier to hire and fire workers is going to resolve anything in the kind of time frame that matters.

The recent string of data warns that Italy's economy may have begun contracting last quarter and may continue to do so into next year. This is likely to bring more austerity and poorer growth, meaning the spiral continues with or without Berlusconi.
This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.