Source: Bloomberg

The soft underbelly of the European recovery is Italian state debt, now at 125% of GDP. Italy has as much debt as Germany with an economy half the size.

The ECB’s “quantitative easing” program bought government bonds from the market, financing Italy’s budget deficit. With quantitative easing looking towards the sunset, the European Commission has proposed other gimmicks to help the Italians finance their debt, such as (European “Safe” Bonds, a form of collateralized debt obligation).

The dirty little secret behind all of this is that the average Italian has more wealth than the average German, even though the German economy is twice the size of the Italian economy and per capita GDP is more than a third larger in Germany. That’s because Italians loot the state to line their own pockets–as in last week’s bailout of two Veneto banks at a cost of EUR 39 billion to the Italian taxpayer.

Senior German officials characterize European Central Bank President Mario Draghi as a “charlatan,” because they know exactly what is going on: German savers and German taxpayers are paying for the foibles and fiddles of the Italians.

At some point, though, the market won’t let Italy get away with further manipulation. The variable to watch is real interest rates–and it started flashing yellow today.