Watch Italy and Germany

Writing at Geopolitical Futures, George Friedman writes that the Italian banking system is overburdened with "non-performing" loans, loans that are not being paid back in full or on time. In truth,

Banks were simply carrying loans as non-performing that were actually in default and discounting the NPLs rather than writing them off. But that simply hid the obvious. As much as 17 percent of Italy’s loans will not be repaid. As a result, the balance sheets of Italian banks will be crushed.

Since the problem is insoluble, the only way to help is a government bailout. (snip) EU regulations make it difficult for governments to bail out banks. The EU has a concept called a bail-in, which is a cute way of saying that the depositors and creditors to the bank will lose their money.

The Italian government is trying to make certain that depositors don’t lose their deposits because a run on the banks would guarantee a meltdown. A meltdown would topple the government.

The reason for the bail-in rule is Berlin’s aversion to bailing out banking systems using German money. (snip) The German sense of victimization is their perception that they are disciplined and responsible, and they resent paying for the irresponsibility of others.

Germany derives nearly half of its GDP from exports. (snip) Germany exports heavily to the EU, and the Italian crisis, if it proceeds as it is going, is likely to cause an EU-wide banking crisis, and an even greater weakening of the European economy.

With the European economy weak, Germany has been exporting to the U.S. If we go into recession too - a downturn is overdue - Germany's economy will take a beating.