And the next Socialist domino is set to fall:

There have been some rumbles about Italy for a while.  Italy’s budget deficits are relatively modest compared to, say, Ireland, but their debt is about 120% of GDP. The government has passed a plan that will balance the budget by 2014, but as with most such plans, most of the cutting comes later, while the current cuts are small.  This may well be sensible fiscal policy, given the current economic climate, but it is not reassuring to the markets.  Mike Shedlock estimates that Italy needs to borrow about €356 billion ($500 billion) in 2011 to cover its deficit, and roll over outstanding debt.  Their 10-years are now trading at something north of 5%.  Most of the estimates I’ve seen say that a debt death spiral becomes likely when rates hit somewhere between 6-7%, because the debt service costs start blowing up the budget deficits.

If Italy goes, it’s not clear that the rest of Europe can save them.  In the FT, Neil Dennis says people are talking about doubling the euro bailout fund to €1.5 trillion–or about three times the size of TARP.  And you may have noticed that the bailout fund has not actually stopped Greece’s descent into debt madness.  Italy’s public debt is not much smaller than Germany’s, even though the latter obviously has a much bigger (and richer) economy.  In the event that things really go south on the Italian peninsula, I don’t think there’s enough money in the rest of Europe to provide a rescue package.

Meanwhile, conditions in the other PIIGSs are worsening.  European leaders seem to be giving up on the notion of some sort of voluntary debt swap after the ratings agencies noted that they would be forced to call this what it is: a default.  Since the Greek debt load does not seem to be in any way sustainable, they’re going to have to do something.  Riots in Athens seem to be making it increasingly clear that over the long term, “something” is not going to be indefinitely decreasing their government consumption in order to make debt service payments.  That leaves making bondholders take some sort of a haircut, aka default.  It sounds as if the continent’s financial leaders are starting to decide that if Greece’s only option is some kind of default, they might as well bite the bullet and do the thing.

This will not be pretty.  For starters, if they default, but stay in the euro, then unless really considerable aid is forthcoming from the rest of Europe, they’re going to lose most of the advantages of the euro (low debt premium) while retaining the disadvantages (excessively tight monetary policy for a country that is going to be experiencing capital flight and even deeper recession).  Countries like Argentina got at least some tourism and export boost from very cheap prices after they defaulted and went off their currency peg; Greece won’t even get that if the euro remains at an ouchy 1.4 to the dollar.  (If it doesn’t remain there, but instead sinks . . . well, that means the euro zone will be having all sorts of other problems.  More on which in a minute.)

They have a chart on the article which shows how interconnected all the banks from the US, Europe and Japan are which means….once a top 10 economy like Italy goes down there will be deep trouble ahead for the rest of Europe’s and US banks. We are in some pretty deep trouble here.

As for Greece:

BRUSSELS -(Dow Jones)- Euro-zone finance ministers have taken a break in their meeting in Brussels, after discussions revealed that a proposal mapped out for private-sector participation in Greece’s next bailout may face impossible hurdles.

The ministers will reconvene after meeting with their countries’ delegates.

In a June 19 Luxembourg meeting, leaders agreed on private-sector participation in the rescue, so long as it is voluntary, substantial and wouldn’t result in selective default.

“The voluntary participation is not going forward,” said one euro-zone official. “It’s over.”

…At the heart of the issue: Credit-rating companies have made clear that any significant effort to make private creditors feel pain would be treated as a debt default by Greece. Most top officials–chief among them European Central Bank President Jean-Claude Trichet–have said letting that happen is unacceptable. However, many officials doubt the ECB would precipitate a banking crisis in Greece by rejecting government debt as collateral.

That leaves Europe with a stark choice: Either make European taxpayers responsible for funding Greece indefinitely, or shift some of the burden to private creditors and suffer a debt default.

Want some more good news from the world markets?

China’s debt is rising as fast as the US– 40% since early 2009 according to Edward Chancellor of the Financial Times, whose column today; “China’s bad debts a cause for concern” is my top pick for must reading. Why? Because while everyone focused on Europe’s debt contagion or calamity. Chancellor quotes Credit Suisse as warning that “Chinese credit growth has reached the critical level that has previously anticipated sudden downturns in other countries.” A great deal depends on China’s ability deal with a raft of non-performing loans without it triggering a sharp economic downturn. Chancellor asks why markets are not more concerned.

It doesn’t end there:

Spanish Budget Gap Adds to Worries

MADRID—The new leader of Spain’s Castilla La Mancha region said on Monday that it has a budget deficit more than twice as large as had previously been thought, raising new concerns over the true state of regional finances and helping to send Spain’s risk premium to records.

If Spain goes over the cliff so does Italy and there is nothing anyone can do about it. No rescue plan would be sustainable.

Trouble ahead folks.