building a firewall around illiquid but solvent countries like Italy
I'm not entirely sure I understand the distinction being made between illiquidity and insolvency here, could someone please explain it? It seems to me that if you are in a state in which a high enough interest rate on your debt will put you in a death spiral from which you cannot feasibly recover, then your problem is bigger than liquidity.
That's exactly the distinction being made. Italy's debt is highish but manageable; it budget deficit is small. If it can borrow at reasonable rates for the next few years, it's not in danger of default. That's illiquidity. Compare to Greece, which, even if it could get loans at low interest, is never going to be able to repay what it already owes. That's insolvent.
So the only thing that really separates Italy from Greece is the market's expectation that Germany won't let any of the other sovereign nations default. Absent that expectation, Italy and Spain are one good speculative attack (a la Soros vs. the British Pound) away from insolvency.
I'm not entirely sure I understand the distinction being made between illiquidity and insolvency here, could someone please explain it? It seems to me that if you are in a state in which a high enough interest rate on your debt will put you in a death spiral from which you cannot feasibly recover, then your problem is bigger than liquidity.