Thursday, 17 November 2011

decision time

In August, I gave an interview to Der Spiegel, saying that the Euro can't last another 5 years in its current form. At the time, many people thought I was nuts. Now, some 3 months later, it looks as if the beginning of the end is near. Yields on AAA-countries like Austria are moving up. Bloomberg reports that Spanish 10-year yields are now above 7%. That's not a catastrophe just yet - Spain can pay a bit more interest, and the debt profile isn't that short-term. But if it lasts any length of time, this is going to be very painful: Higher interest rates mean that the country will need more austerity measures to keep the future debt path under control; output will fall yet further; yields may increase even more. It's now abundantly clear that the last rescue package was a disaster on a monumental scale - forcing a 50% haircut on the private creditors felt good, but now everyone is asking who will be next. If all the promises over Greece were worthless, is the same true for Spain and Italy? Of course; they are too big to rescue outright. The only solution is to convince the markets to keep buying. It's a confidence trick that makes the markets work; once confidence goes, the spreads explode. The more people worry, the higher the yields, the higher the collateral requirements, the weaker the banks.

As the ECB tried to tell politicians for the last year - sovereign bonds are too important as a risk-free asset in the financial system to mess with them. The only solution now, to avoid defaults of Spain and Italy in the near future, is to offer a blanket guarantee of all existing EU debt, incl. Greece; undo the haircut on Greek bondholders; and introduce unlimited bond-buying by the ECB. I won't like it any more than the average German, but there is really no alternative short of a wholesale implosion of the weaker Eurozone economies.  

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