No, the euro crisis is not over yet. The recent turbulence has certainly subsided, but far too many imponderables lie ahead for us to sound an all-clear signal.
Twenty-eight basis points, 0.28%: that was the paper-thin margin on 12 January between tranquility and havoc on European markets. But the invisible hand of the market formed a thumbs-up and Portugal managed to place its 10-year government bonds at 6.72%.
Had the threshold of 7% been reached, Lisbon would have very likely needed support from the European Financial Stability Fund (EFSF), raising the curtain for another act in the European sovereign debt drama. And that act would have closed with Spain, whose financial intermediaries are closely interlinked with those of its Iberian neighbor, quivering fearfully in spotlights. Fortunately, this didn’t happen.
More good news came on 25 January, when the EFSF’s debut issue of a five-year, AAA-rated EUR 5bn bond was successful, and even several times oversubscribed, at 2.89%. Those two events led many pundits to conclude the Euro crisis was over. I remain skeptical.
Despite several colleagues patiently explaining to me that a liquidity premium may account for it, I find it dubious that the 5-year AAA bond from the EFSF can yield 0.5% more than a 5-year AAA bond from the German government. Is the EFSF bond really as triple-A safe as Germany’s bond? And isn’t this exactly the sort of question many failed to ask in the wake ofß prior to? the last financial crisis?
Technicalities aside, I think sounding an all-clear on the euro crisis may momentarily recast it as a tedious but manageable economic problem but dangerously ignores the vital and far less manageable political dimension. Wishful thinkers on the euro cite some implausible reasons for their optimism.
Yes, as they argue, Germany could easily underwrite Greece’s entire sovereign debt – which amounts to roughly 4% of Germany’s GDP. And why not toss in Ireland and Portugal’s debts as well? Sorry, but I seriously doubt the German constitutional courts and the German public would agree to this philanthropic gesture.
And granted, the latest data shows Spain starting to increase its competitiveness. But chipping away at its 30% gap in unit labor costs with Germany will be a long and painful process for Madrid, especially with unemployment at over 20%.
Agreed, Greece has begun to implement harsh austerity measures. However, it is meeting grassroots resistance, for example, some people are refusing to pay health and transportation fees. A tax boycott is certainly thinkable in Greece. And who could blame the Greek populace for rejecting such deep sacrifices to rescue such a broken system?
Ireland will probably kick out the sitting government when it votes on 25 February, and the new government may not pursue all the policies the old one has agreed to. Meanwhile, the situation in Belgium is utterly confusing. The country has had no government for eight months now. If it would split into two linguistic entities – a rather ugly reminder that a political union is never forever – who would be responsible for the Belgian government’s immense debt?
Stabilizing the Eurozone with the EFSF can work as long as only the smaller countries need help. But this construct would be sorely tested if, for example, Spain were to falter.
Alternatives like the proposed Eurobond should also be viewed skeptically. We know since the financial crisis that the alchemy of mixing AAA and sub-investment grade debt cannot magically yield a new shiny AAA bond, with Germany as the super-senior tranche and Greece in the mezzanine.
In our view, the only way to relieve the chronic sovereign debt crisis at the Eurozone’s periphery is to mimic the Americans’ approach to US subprime debt: the European Central Bank will have to buy that “toxic” sovereign debt from European financial intermediaries until the balance sheets of the latter are considered stable enough to allow some European peripheral countries to default and reshuffle their debt without triggering a banking crisis in Europe’s core.Of course, this scenario will not please Germany, since monetization of European peripheral debt will ultimately lead to more inflation. But if European politicians vow, like French President Nicolas Sarkozy in Davos last month, “Never will we abandon the euro,” inflation is the price that must be paid.
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