By Marcus Walker 

ROME -- The end of Greece's marathon bailout on Monday would mark the closure of the eurozone crisis -- if only it weren't for Italy, and nagging fears that the euro isn't fixed after all.

European Union authorities will hail as a victory the completion of Greece's financial-rescue program, an eight-year drama that triggered a wider European sovereign-debt panic. Greece's economy has begun to grow again, although recovery has far to go. Defying many predictions, Greece has stayed in the euro, thanks to the strength of public support for keeping the currency, even amid one of the deepest economic depressions of modern times.

Meanwhile French President Emmanuel Macron, German Chancellor Angela Merkel and other EU leaders are discussing the next moves to bolster the currency union, building on various overhauls since the crisis.

Italy shows it might not be enough.

Renewed market tremors last week over Italian debt, and fresh verbal attacks on Europe's establishment by politicians in Rome, suggests the specter of destabilizing capital flight from a eurozone country could return.

A first test will come this fall, when Italy's new populist government must present a budget and explain how it will pay for its costly promises to voters.

"I am as serene as the rainbow," parliamentary budget committee chairman Claudio Borghi tweeted on Aug. 13 as investors sold off Italian bonds. Either the European Central Bank will guarantee Italy's debt, "or everything will be dismantled," said Mr. Borghi, a euroskeptic economic adviser to Matteo Salvini, head of Italy's nationalist League party.

A day later, the prime minister's office sought to reassure investors with a statement pledging fiscal discipline.

EU authorities have drawn many lessons from bond-market breakdowns that nearly destroyed the euro in 2010-12. They have built safeguards ranging from a permanent bailout fund to centralized banking supervision. Leaders are haggling over an embryonic common budget for the eurozone.

But the causes of Europe's debt crisis haven't gone away.

The currency union facilitated massive capital flows during the 2000s from Europe's economic core around Germany to its periphery. That fed credit bubbles that distorted national economies, then left whole countries gasping for liquidity when investors lost confidence and fled.

Advanced economies, which normally control the currency they borrow in, became as vulnerable to investor stampedes as emerging economies -- such as Turkey -- that borrow in foreign currencies.

The euro still feels like a foreign currency to some Italians. The euroskeptic Minister for Europe Paolo Savona has called it a "German cage." During the crisis, the ECB acted to save Italy's bond market from collapse only after Rome inflicted painful fiscal austerity to satisfy the central bank and Berlin.

The nativist League, part of Rome's new governing coalition, feeds partly off lingering resentment about perceived German bullying.

ECB intervention in bond markets from 2012 onward, led by the bank's Italian president Mario Draghi, was the key to ending the financial disintegration and saving the euro. Government-to-government loans were enough to bail out smaller countries such as Greece, Ireland and Portugal -- but only the ECB has the firepower to defend Italy, with its EUR2.3 trillion ($2.6 trillion) national debt.

Mr. Draghi, who retires next year, famously vowed to do "whatever it takes." But he also needed supportive political leaders in Berlin, Rome and other important capitals.

"Are we sure that the next ECB head will be willing to do that?" says Paul De Grauwe, one of Europe's most prominent economists. "Are we sure the political configuration in Europe will allow it? We don't really know." In an age of voter backlash against Europe's political establishment, he says, "the leading actors next time may not be as invested in saving the euro."

Italy's new governing coalition, comprising the League and the antiestablishment 5 Star Movement, dominates in opinion polls at the expense of Italy's centrist establishment, which backed the austere fiscal policies in the crisis. Neither governing party advocates leaving the euro, but each contains vocal euro-skeptics and has in the past called for a referendum on returning to the lira.

"If markets are seen as punishing Italy, it could intensify political animosity against the eurozone," says Mr. De Grauwe.

Optimists say Europe has made good progress in reducing one of big reasons why the debt crisis escalated: the mutual dependence of banks and governments.

When government-bond prices plunged, inflicting losses on banks that held them, markets doubted that crisis-hit governments could afford to support their country's banks, leading to more selloffs. Struggling banks choked off credit to their national economies, deepening recessions.

Europe's new banking union, still under construction, aims to break vicious circle. In future, the Europe-wide banking sector and its investors are to carry the cost of bank failures, rather than taxpayers.

"We may be closer to disentangling banks and sovereigns than in generally realized," says Nicolas Veron, senior fellow at Brussels think tank Bruegel. "Even so, I would recommend going much further," by deterring banks from owning too many of their government's bonds.

Ideally, says Mr. Veron, bond markets would be able to punish governments for reckless policies, without capital flight spilling over into banks and the wider economy.

Others say the banking union isn't enough. A banking crisis such as 2008 would overwhelm the sector's limited new defenses, again burdening governments. Italy's bond market is so big that a crash can't be isolated from the economy, especially if linked to fears of a euro exit.

And the eurozone still lacks tools to fight recessions in countries where its brittle bond markets force governments to cut spending in a recession. The small eurozone investment fund envisaged by Mr. Macron and Ms. Merkel would be largely symbolic.

Ultimately the euro's defense rests on the unwillingness of ordinary European voters to see their savings and livelihoods decimated in the chaos of a breakup, says Jacob Funk Kirkegaard, senior fellow at the Peterson Institute for International Economics in Washington.

"This is the key lesson of the Greek crisis," he says. "Leaving the euro perhaps isn't impossible, but the costs are so catastrophic that, politically, it's unbearable." That is why Greece turned back from the brink of exit in 2015.

"And Italy -- a richer country with high savings that's more deeply integrated into the European economy -- has so much more to lose than Greece."

Write to Marcus Walker at marcus.walker@wsj.com

(END) Dow Jones Newswires

August 19, 2018 07:14 ET (11:14 GMT)