THE financial markets don’t know which way to look. On both sides of the Atlantic we have a debt disaster that would be a recipe for short fingernails.
But despite today’s headlines, it is Europe that presents the far greater risk to the global economy. While what is happening in Washington has now descended into political farce, it is the Eurozone that has moved into a far more critical phase.
The deal done in Brussels on 21 July was initially seen as having the potential to put Greece on a more sustainable path and to prevent contagion. With the benefit of hindsight it is clear this assessment was wrong.
Peripheral bonds yields have widened against Germany and the euro has started to fall again. One of the most obvious reasons for this is that politicians themselves don’t seem to understand the deal that they produced or at can't communicate it to everybody else.
The result is that Europe has taken one step back. It’s now clear that the day of reckoning for Greece has only been delayed and a hard restructuring is still the most likely end game.
More worrying though is that by taking Greece out of the limelight for the time being the focus on Spain and Italy has become more laser like.
While the Spanish ten year is once again yielding over six per cent, it is Italy that could provide the greatest shock and once again it is politics that will be causing ripples.
While the elections in Spain in November will likely put a more fiscally responsible government in place, the situation in Rome could become could quickly become chaotic if finance minister Guilio Tremonti were to resign and bring to end the reign of Silvio Berlusconi.
In such a scenario Italian BTP yields would rise rapidly and become unsustainable. Italy’s stock of debt dwarfs Germany’s. Helping Italy in the way that Greece, Ireland and Portugal have been is not possible. If Italy needs help it’s game over for the euro.
To make matters worse it is not clear that the global economy is slowing rapidly. Central bankers in Frankfurt could have seriously misjudged the situation by raising rates twice already. Fifty basis points does not represent a substantial increase in the cost of borrowing but it could be significant for countries such as Italy. Jean Claude Trichet has a lot to think about as he comes to the end of his time at the top of euro towers.
Guy Johnson presents Closing Bell on CNBC