This morning, as the data were coming in from Europe for Q1 GDP, I got a reminder from Twitter about the inherent deflationary nature of the euro area’s design. And this goes directly to how to think about credit risk in Europe.

I followed a twitter post to a Charles Goodhart article from 1997, written before the European Monetary Union and he was saying things that the late British economist Wynne Godley was banging on about five years earlier when the Maastricht Treaty set out the terms for euro. Here’s the crux as it relates to credit risk in Europe:

The conventional economic analysis of Emu compares the balance of savings in transactions costs-the cost in money, convenience and risk of dealing in more than one currency-against a potential worsening of difficulties in macroeconomic adjustment. After all a country’s declining competitiveness can be mediated, and the blow softened, by a declining exchange rate. If there is no insulating national currency, declining competitiveness must translate directly into unemployment. Proponents of Emu tend to be both more optimistic about the size of the transaction cost saving, and more sanguine about any worsening of adjustment difficulties. Those more sceptical about Emu stress the absence of a trans-European mechanism to aid adjustment by transferring wealth from rich areas to poor areas via taxes and benefits, as occurs now within nations. They also doubt the magnitude of the transaction cost savings, and contest the claim of Emu supporters that without a single currency the single market is threatened. Both sets of arguments quickly progress from the economic to the political.

Here’s what Goodhart was saying: Emu was created or mostly political reasons. That’s why when you argue about the economics ofthe eurozone, the argument quickly turns political. The whole affair was a political construct right from the start. And so the examination of the economics of Emu amongst policymakers was deficient.

Goodhart believes that had policymakers examined how Emu was set up, they would have discovered that the declining transaction costs of a common currency simply couldn’t make up for the economic losses from a loss of sovereignty – unemployment, economic crisis, and — most importantly here — default risk.

Here’s how Goodhart puts it, with an example using Belgium – then a problem child in Europe because of its high government debt load:

But what happens after Emu when there is a drop in the demand for the bonds of a particular national government? What if, for example, bond investors start to see Belgium as a worsening credit risk: it has an ageing population, a declining tax base, and a government which lacks the political will to trim its spending programme. There is a risk of a rapidly self-reinforcing run in the bond market: higher interest rates which worsen the government’s current deficit, which in turn both increases its need to sell bonds and reduces demand for them. Such a run would be the equivalent, within Emu, of the periodic foreign exchange market crises which have plagued medium sized open economies (such as Britain) over the years. But these bond market crises could be much worse than their foreign exchange market forebears if the contagion threatened to spread from the debt of governments to that of the banks, and the financial system itself was thereby undermined. [emphasis added]

Isn’t this exactly what happened in the eurozone after 2010?

Why this matters. The euro area is doing extremely well right now. Even so, yesterday ECB President Mario Draghi told the assembled press after the ECB rate decision that the central bank was in no hurry to tighten monetary policy. That’s positive for European sovereign bond yields.

But let’s be under no illusions here. Everything that Goodhart said in 1997 is still true today in 2017. And it isn’t Belgium that is the problem child these days; it is Italy, a much bigger and more important country for Emu. And everything Goodhart said about an ageing and economically sclerotic Belgium in 1997 is true in spades for Italy in 2017.

The bottom line: Italy is going through a turbulent political period that makes it a worsening credit risk. It needs growth. And to get that growth, it needs change politically. There are elections in early 2018. But even before we get there, Italy’s social democrats are about to elect a new leader. And it isn’t guaranteed it will be Matteo Renzi. Where will the so-called reforms come from to stimulate the economy? I don’t see it happening.

What happened in 2010 with Greece, Spain, Portugal and Ireland will happen again. But this time, Italy will be the first domino to fall. And when it does fall, Italian sovereign and bank credit risk will skyrocket. Caveat Emptor.