Another day, another crisis

July 12, 2011

By Laurence Copeland. The opinions expressed are his own.

Here we go again – the same sickening feeling, as stock markets reel amid a flight to “safety”. For months, there have been worries about contagion from the Greek imbroglio, and now the nightmare seems to be coming true, as one after another the weak European economies are put to the sword.

First came Greece and Ireland, then Portugal, now it’s the big league – Spain and, even bigger, Italy (and don’t forget Belgium, an accident waiting to happen for many years now, not very important in pure economic terms, but psychologically significant as the home of the whole sorry euro disaster).

In the table below, you can see how much Governments were being forced to pay for borrowing on the markets yesterday (July 11). The rates quoted for Greece, Portugal and Ireland imply that borrowing in the bond markets is for all practical purposes out of the question for those countries, as that has been the case for some months past, but the new development is that Italy and Spain are now being forced to pay 6 percent for 10-year loans, a premium of more than 3 percent compared to Germany.

Bond  yield
GREECE 17.3%
ITALY 5.9%
SPAIN 6.1%
UK 3.1%
USA 2.9%
JAPAN 1.1%
Source: Financial Times















What this means is that, for exactly the same type of loan promising repayment on the same date in 2021, the Italian and Spanish Governments have to offer over twice as much as the Germans in order to compensate lenders for the risk that they will not be repaid in full. To put this in perspective, remember that for most of the life of the euro zone, yields on Government debt were locked within a tight range of 0.25 percent (one quarter of one percent or 25 basis points) of the German rate.

Moreover, look at the yields on non-euro zone debt. Switzerland pays only 1.6 percent – it has a reputation for rock-solid finance going back over many decades – and Japan pays even less, in spite of having the largest national debt-to-GDP ratio of any industrialised country (albeit matched by a mountain of accumulated private savings). Even Britain, which is only just making a start on putting its house in order, and America, which is still thinking about it, are still able to borrow at around 3percent – less than half a percent above what it costs Germany, and less than France has to pay.

Maybe there is something in the observation that markets can only deal with one issue at a time. Since they are currently focussed on default risk, they seem willing to lend freely to non-Eurozone Governments, presumably on the grounds that they will always repay their debts, if necessary by printing money (or quantitative easing, as it is euphemistically called) – oblivious to the fact that this must ultimately lead to inflation, meaning that lenders will be repaid in devalued currency.

In short, it would take a lot more than 3 percent to persuade me to buy either British or American conventional (i.e. non-indexed) gilts.

Yesterday also saw a development in the credit default swaps market which may be noteworthy. While the cost of insuring against a default on Italian bonds rose by over 20 percent, so too did the cost of insuring German, French, Belgian and Dutch debt – in each case by about 15 percent. This could well be a straw in the wind, indicating that the markets are waking up to the fact that Germany cannot carry on being the euro zone’s sugardaddy without endangering its own creditworthiness.

It may well be that, without making any outrageous assumptions, a true calculation of Germany’s implied debt-to-GDP ratio may already be at Italian or even Greek levels, once we take account of its contingent liabilities to bail out its southern neighbours – especially if we take seriously (as we  should, in my opinion) the fear that, once having been bailed out, the peripheral countries will revert to type and start spending again.

Another day, another crisis. But in the daily chaos, we should not lose sight of the general lesson which the euro-mess exemplifies.

This is where top-down Government gets you. From the outset, the EU’s modus operandi has remained a matter of leaders negotiating in secret, emerging to announce their triumphant agreement, before working out how to foist it on their reluctant electorates. Doubters had to be sidelined or slapped down in no uncertain terms. Referenda, if absolutely unavoidable, had to be rigged – or repeated until a yes vote was achieved.

In the present case, any open democratic process would have seen the proposal for European Monetary Union decisively rejected by France and Germany and almost certainly other countries in today’s euro zone too (in addition of course to Britain, Denmark and Sweden), saving us from the current disaster.

And even if somehow the German electorate had been persuaded in a referendum to support the project when it was originally proposed back in 1992, it would today be far easier for Chancellor Merkel to ask her taxpayers to cough up yet again for the sake of the monetary union they had themselves democratically endorsed at its inception. Instead, as things stand, they have every right to be enraged. Their passivity is commendable – but I wonder how long it will last, once they see the impact on their tax bill. I wouldn’t want to be around when they start looking for who is to blame.

(Hint for German readers: Helmut Kohl was a historian, who twice proved that economists do have a use after all).

Image: Finance ministers Michael Noonan of Ireland, Evangelos Venizelos of Greece, Elena Salgado of Spain, and Francois Baroin of France (L-R) sign the treaty establishing the European Stability Mechanism before a euro zone finance ministers meeting in Brussels July 11, 2011. REUTERS/Thierry Roge

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