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Generational Dynamics Web Log for 7-Sep-2010
7-Sep-10 News -- Europe's bonds return to crisis levels

Web Log - September, 2010

7-Sep-10 News -- Europe's bonds return to crisis levels

Belgium is close to total dissolution

Europe's bonds return to crisis levels as summer season ends

European Union finance ministers, arriving for a two-day meeting in Brussels, expressed satisfaction with the progress so far. German Finance Minister Wolfgang Schaeuble was quoted by Bloomberg as saying. "Developments in the first half were rather good. [The result is] a slight slackening of the dynamism to draw consequences."

I was wondering what that peculiar last sentence meant, until I read a France24 article quoting Schaeuble as conceding that with each passing week it seemed that "the enthusiasm for learning the lessons is weakening bit by bit."

In other words, now that the crisis is "over," there is less and less enthusiasm among the finance ministers to pass needed reforms.

And what are those needed reforms? Well, Reuters says that the finance ministers want to impose a tax bank profits and financial transactions, so that they can get a new windfall of money for their various spending programs in each of their countries. Gag me with a spoon.

While this farce is going on, bond spreads are deteriorating to the levels that led to the Greek bond crisis and the gargantuan bailout last May. (See "11-May-10 News -- Europe's super-nuclear bailout.")

Wolfgang Münchau, the widely respected columnist for the Financial Times (Access), says, "Do not fall for talk of European solvency." According to Münchau,

"While the Europeans are celebrating the end of the financial crisis, something strange is happening in the bond markets. The gap in the yields – the spread – between the 10-year bonds of peripheral eurozone countries and Germany has been growing at an alarming rate. It is now close to the level that prevailed in the days before the European Union decided to set up its bail-out fund in May.

Last Friday, the spreads were 3.4 per cent for Ireland, 9.4 per cent for Greece, 3.4 per cent for Portugal, and 1.7 per cent for Spain. The yield on 10-year German bonds is currently ridiculously low, about 2.3 per cent. The financial markets somehow regard Germany as a paragon of virtue, stability and sound financial management, and are happy to demand virtually no return on 10-year investments. If the bond markets were ever returned to normal, and if the spreads were to persist, peripheral Europe would find itself subject to an intolerable market interest rate burden."

What this stuff about "bond spreads" means is the following: Many investors are putting their money into what they consider to be the safest places -- German 10 year bonds, that are paying an incredibly low interest rate of 2.3%. (Incidentally, U.S. 10 year bonds are in that ball park as well.) But investors consider bonds from other countries to be much riskier investments, and they're demanding much higher interest rates: 2.3%+3.4%=5.7% for Ireland, 2.3%+9.4%=11.7% for Greece, and so forth.

These rising interest rates indicate a rising conviction among investors that these other countries are going to default, and not pay their debts. This creates a "vicious spiral," where rising interest rates mean that a country has to pay more to borrow money, which means that there's an even high chance of default, which causes investors to demand even higher interest rates, and so forth, round and round.

Münchau says that Greece's adjustment program is going much better than anyone had hoped, but even so, it isn't enough to prevent insolvency. He concludes, "Yes, it is possible that Greece will get through this crisis, and repay all of its debt. But it is far more likely that parts of peripheral Europe will end up only repaying parts of their debt. That is what the bond spreads are telling us, and I think that the bond markets have got this one right."

None of this should be a surprise to regular readers of this web site. It was absolutely certain last May, when the "super-nuclear bailout" was announced, that Greece was going to default anyway, and I wrote about it several times. But now that the summer doldrums are ending, there is increasing focus on this reality.

Meanwhile, things are also going poorly on this side of the Atlantic. Nouriel Roubini is quoted by the Telegraph as saying that the United States, Japan and large parts of Europe have exhausted their policy arsenal, leaving them defenseless against a double-dip recession. "We have reached stall speed. Any shock at this point can tip you back into recession. With interbank spreads rising, you can get a vicious circle like 2008-2009."

Belgium is close to total dissolution

Belgium <font size=-2>(Source: CIA Fact Book)</font>

Belgium (Source: CIA Fact Book)

After the resignation of a key mediator over the weekend, leading politicians are now openly talking about the prospect of breaking up Belgium, according to EurActiv.

Since Belgium was created in 1830, it's been two countries in one: 6 million Dutch speakers in the flat, northern lands of Flanders (the Flemish), and 4 million French speakers in the southern region of Wallonia (the Walloons). Many Flemish voters are increasingly frustrated at having to subsidize social security bills in the poorer, French-speaking south, where the collapse of traditional industry has led to much higher unemployment than in the north.

For this reason, the Flemish generally favor breaking up the country, while the Walloons tend to oppose it. However, one stumbling block to a breakup is that both sides wish to claim the capital city, Brussels. Over 80% of the population of Brussels is French-speaking, but the city lies on the Flemish side of the border. To make the point, on Sunday, thousands of Flemish separatists took part in an annual demonstration, that consists of symbolically encircling Brussels by bike to remind locals that they are surrounded by Flanders.

A breakup of Belgium could lead to financial disaster, according to Reuters. The country's debt is already the third highest in Europe, and is expected to be greater than the country's GDP next year. A breakup could only make things worse.

In fact, bond spreads for Belgian debt have already begun to rise on fear of a breakup, according to Market News.

Additional links

Something that I've felt for a long time is that the enormous stimulus and bailout packages are not only not helping the economy, but are actually making it worse by using up resources to delay the inevitable crash, which will then be worse than it would have been. Apparently some mainstream economists are starting to adopt this view, and favor letting housing prices crash right away, rather than spending large amounts of money to prop up the housing market temporarily, which is what we've been doing. NY Times

France's public sector labor unions began their nationwide strike on Monday, with the worst effects to be felt on Tuesday. They're protesting pension reform including the horror of having the retirement age raise from 60, where it is now, to 62. Associated Press

Another day, another suicide attack in Pakistan. On Monday, a terrorist ramed his explosives-laden vehicle into a police station in northwest Pakistan, killing 19 people, including women and schoolchildren. There's been a lull in these suicide attacks for a while, apparently because the terrorists were as disabled by the massive floods as ordinary people were. But now, this is the third major suicide attack in Pakistan in the last week. Dawn

(Comments: For reader comments, questions and discussion, see the 7-Sep-10 News -- Europe's bonds return to crisis levels thread of the Generational Dynamics forum. Comments may be posted anonymously.) (7-Sep-2010) Permanent Link
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Generational Dynamics Web Log for 7-Sep-2010 7-Sep-10 News -- Europe's bonds return to crisis levels

Europe's bonds return to crisis levels as summer season ends

Belgium is close to total dissolution

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Generational Dynamics Web Log for 7-Sep-2010
7-Sep-10 News -- Europe's bonds return to crisis levels