Italy faces two scenarios as the coronavirus paralyzes its economy, neither of them pleasant.

The first assumes that the tight quarantine imposed last week will work its magic and the horrendous rise in COVID-19 infections and fatalities will peak in the next month or so and go into decline, following the trend in China.

Under this scenario, the quarantine would be eased off. Italy would not escape a deep, nasty recession but would bounce back some time in the latter half of the year, when the factories, hotels and restaurants emerge from cold storage and the tourists venture back to Tuscan villages and Roman pizzerias.

The second scenario assumes a catastrophe. The outbreak intensifies, perhaps because the quarantine springs leaks, hospitals are overwhelmed (many are already), and everything from car factories to small shops remains closed or largely closed. Forget recession – the economy goes into depression. The Italian newspaper La Repubblica, using data from Cerved Group, a credit-risk analysis company, says this scenario could cost Italian businesses almost €650-billion (around $1-trillion) this year and next.

The catastrophe scenario cannot be ruled out, and that’s why all eyes are on Italy, the European Union’s and the euro zone’s third-largest economy. If Italy collapses, the entire euro zone could collapse with it. The euro barely survived the 2008 financial and debt crisis – Greece came close to Grexit, Italy to a sovereign bailout. The coronavirus crisis will test the common currency once again, perhaps more so than it did a decade ago.

The question is whether Europe will come to the aid of Italy or whether it will be left to fend for itself. So far, the EU and the European Central Bank have taken an every-country-for-itself approach, even though the head gnomes of both institutions are offering soothing words and some stimulus and bank assistance measures.

Sorry, I take that back, because the ECB has actually damaged Italy. Last Thursday, Christine Lagarde, the new ECB president, said the bank “was not here to close [yield] spreads” between, say, German and Italian bonds.

Her remark hit the Italian debt market like a bomb. Yields on Italian 10-year bonds shot up at a record pace and stayed up as their prices plummeted (yields and prices go in opposite directions). By Monday, the Italian yield had climbed to 2 per cent, putting the spread, or gap, between it and German bonds at a gaping 2.5 percentage points, almost as wide as the Greek spread. While Ms. Lagarde was technically right, casting Italian debt to the dogs in the middle of a pandemic was rather callous. Among the big European economies, Italy can least afford expensive debt, especially when it’s plunging into its fourth recession in a dozen years.

And that’s the point. Italy was an economic zombie even before the term “COVID-19” was invented and has approximately zero financial wiggle room to prevent a recession from deepening into a depression as the virus rampages through the country. The Italian coronavirus outbreak is the most intense in the world after that of China, and the Italian north is the disease’s new global epicentre.

Italy has a crushing debt load, with a debt-to-GDP ratio of about 135 per cent (Germany’s is less than half that level). Its banks are loaded with non-performing loans, and the youth unemployment rate is 29 per cent. Germany, which is running budget surpluses, is preparing a €500-billion fiscal stimulus package to shield its companies and their workers from the impact of COVID-19. Italy struggled to come up with €25-billion for a similar mission.

If Italy had its own currency, it might have a fighting chance to launch, in effect, an internal Marshall Plan by devaluing and printing money. The country cannot devalue because it doesn’t issue its own currency – the ECB does that for the 19 countries in the euro zone.

Which brings us to the Italian populists. In 2008, the anti-establishment Five Star Movement and the far-right, anti-migrant League won the national election, partly on a euroskeptic platform. League Leader Matteo Salvini used to call the euro a “mistake” for Italy and he was probably right; Italy has been in economic stagnation since the currency was launched two decades ago (he now denies he would try to take Italy out of the euro if he were to become prime minister).

But the COVID-19 crisis seems perfect for his political ambitions: He could argue that the “foreign” virus is attacking his country and a “foreign” currency is acting like a straitjacket on the Italian economy. It may work. With little help from the EU and the ECB, Italians may lobby for the revival of the lira, a currency they could control.

Italy and Europe are entering uncharted territory. Under the coronavirus catastrophe scenario, Italy might need precautionary lines of credit from the European Stability Mechanism, the euro zone’s bailout fund. But the amounts needed for a country with a bigger economy than Canada’s would have to be enormous. What is virtually certain is that Italy is going to need a lot of help from internal and external sources this year. What is also virtually certain is that if the help doesn’t come and Italy collapses, the euro will collapse with it.

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