European depression watch eases oh so slightly

 The basic problem confronting the eurozone right now is that the European Central Bank refuses to act as a lender of last resort. Outside Greece, most of the other countries are perfectly healthy as long as interest rates don’t rise too high. (Consider Portugal.) Of course, that’s the rub. As interest rates rise, debt levels start to look less sustainable. As debt levels start to look less sustainable, people sell their holdings of the debt. As people sell their holdings, interest rates rise. As interest rates rise, rinse and repeat.

Normally, a central bank would come in and calm things down by promising to purchase new debt at a reasonable interest rate. This is why Britain and the United States have had no problems; everyone knows that their central banks stand ready. Eurozone countries, however, don’t have their own central banks. That makes them vulnerable to self-fulfilling panics.

And here’s the second rub: Germany also lacks a central bank! So why should Germany be immune? To some extent, the country is protected by the fact that it’s the safe haven: when people sell other countries’ bonds, they buy German ones. But that’s only partial. Speculation has hit countries as healthy as Germany, like Austria and Finland. Considering as there still are other places to park your money (U-S-A! U-S-A!), and the European Central Bank is still doing its level best to start a second Great Depression, then there is no reason why German bonds should be invulnerable to the panic.

And lo! Germany just had a failed bond auction. Yields rose from 1.98% to 2.07%, far from a disaster, but not a good thing in economic terms. In fact, it is worse than you think. So what’s the silver lining?

Simply that if Germany starts to be affected, then Angela Merkel will stop being evil.

I should add here that other analysts think that Germany’s pain threshold is far higher than a blip in yields or the collapse of the eurozone’s repo market. “In other words, the time to sell bunds will be when Germany finally realises the game is up and reluctantly props up the Eurozone, probably via the printing presses of the ECB. Unfortunately, that won’t happen until Eurozone has a near death experience with countries threatening to leave the currency union and customers lining up outside banks demanding their money back.”

If that’s right, and it probably is, then we’re in trouble. But I’ll still say that on the margin we’re at least a millimeter closer to sanity than we were yesterday.

Comments

[Will Baird]

Comments on the new treaty that's taking shape? Will they finish it in time?

[Will Baird]

The European situation is crying out for an update! Or at least your peanut gallery is crying out for one!