by Don Quijones, Wolf Street:

The only other option: “Orderly restructuring.”

Here’s the staggering scale of the Italian government’s dependence on the ECB’s bond purchases, according to a new report by Astellon Capital: Since 2008, 88% of government debt net issuance has been acquired by the ECB and Italian Banks. At current government debt net issuance rates and announced QE levels, the ECB will have been responsible for financing 100% of Italy’s deficits from 2014 to 2019.

But now there’s a snag.

Last month, the size of the balance sheet of the ECB surpassed that of any other central bank: At €4.17 trillion, the ECB’s assets have soared to 38.8% of Eurozone GDP. The ECB has already reduced the rate of purchases to €60 billion a month. And it plans to further withdraw from the super-expansionary monetary policy. To do this, according to Der Spiegel, it wants to spread more optimistic messages about the economic situation and gradually reduce borrowing.

Frantically sowing the seeds of optimism on Wednesday was Bruegel’s Francesco Papadia, formerly director general for market operations at the ECB. “On the economic front, things are moving in the right direction,” he told Bloomberg. The ECB will begin sending clear messages in the Fall that it will soon begin tapering QE, Papadia forecast. By the halfway point of 2018 the ECB would have completed tapering and it would then use the second half of the year to move away from negative interest rates.

So far, most current ECB members have shown scant enthusiasm for withdrawing the punch bowl. The reason most frequently cited for not tapering more just yet is their lingering concern about the long-term sustainability of the Eurozone’s recent economic turnaround.

The ECB’s binge-buying of sovereign and corporate bonds has spawned a mass culture of financial dependence across Europe, while merely serving to paper over the cracks that began forming — or at least became visible — in some Eurozone economies during the sovereign debt crisis. In many places the cracks are even bigger than they were back then. This is the elephant in the ECB’s room, and by now it’s too big to ignore.

In one country alone, the cracks are so large that they could end up fracturing the entire single currency project. That country is Italy.

Astellon Capital’s report on Italy’s dependence on ECB bond purchases poses the question: If the ECB tapers its purchase of Italian bonds further, who would pick up the slack?

The Italian banks, which are themselves deep in crisis mode and whose balance sheets are already filled to the gills with Italian bonds? Hardly. When QE ends, the banks are more likely to become net sellers, rather than net buyers, of Italian debt. The only way for the game to continue is if over the next six years non-banks increase their purchase activity up to seven times that of the past nine years.

In other words, the very same investors who have used QE as the perfect opportunity to offload the immense risk of holding Italian liabilities onto the Bank of Italy’s, and then onto the Eurosystem’s, would need to step back into the market in a massive way, just at a time that the country in question is on the verge of a full-blown banking crisis.

That is not going to happen. As such, when the only large purchaser of Italian debt, the ECB, gradually leaves the market, the inevitable result is going to be soaring yields. Italy’s debt overhang and the cost of servicing it are guaranteed to grow.

Rome is well-accustomed to shelling out vast sums of money on servicing the interest on its gargantuan debt, now at 135% of GDP. Since 1995, the country has spent the equivalent of 5.5% of annual GDP on servicing its interest costs. That’s one of the highest rates in Europe, over double that of Spain and just one percentage point lower than Greece’s.

At the height of the sovereign debt crisis, in 2012, Italy’s government lavished €84 billion on interest costs alone. By 2015 that sum had shrunk to €69 billion, its lowest point in seven years, as a direct consequence of the ECB’s QE program which pushed down Italian yields. When the effects of that program are withdrawn, it won’t be long before Italy’s government begins suffering the pangs of withdrawal symptoms.

According to Astellon Capital, the only long-term solution to this problem is to carry out an orderly restructuring of Italian debt. In fact, by this stage in proceedings, the stark choice is between an orderly or disorderly restructuring of Italy’s debt.

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