November 24th, 2011
Econintersect: Germany has fiddled while their own house was burning and now the embers and ash may be starting to fall around them. Or maybe not – it all depends on who is listened to. At any rate the bond market fired a shot across the German ship bow Wednesday when a ten-year auction was not fully subscribed. To be more precise, Germany was forced to eat about a third of the offering due to an absence of bidders. And the yield for the AAA ten-year bund ended at 1.98%, higher than the AA U.S. ten-year at 1.95%. And the AAA rated ten-year bond in France now yields 3.63% (Bloomberg/Businessweek). So much for rating agencies!
Some quotes from Reuters regarding the meaning of the German auction and the ongoing disagreement about the role of ECB bond issuance in the crisis:
- "Bunds are starting to lose their appeal because markets have to believe the euro bonds story and Germany is very close to starting, essentially, to guarantee the debt of other countries," said Achilleas Georgolopoulos, strategist at Lloyds Bank in London.
- "It's quite telling that there has been upward pressure on yields in Germany - it might begin to change perceptions," David Beers of Standard & Poor's told a conference in Dublin.
- "It is a complete and utter disaster," said Marc Ostwald, strategist at Monument Securities in London. (Referring to the failed auction.)
- "The debt crisis is burrowing ever deeper, like a worm, and is now reaching Germany," one of the more eurosceptic backbenchers in Angela Merkel's center-right government, Frank Schaeffler of the Free Democrats (FDP) who are the junior coalition partners.
- In a forceful speech to the Bundestag lower house of parliament, Merkel issued one of her starkest warnings yet against fiddling with the bank's strict inflation-fighting mandate. She also hit back at proposals from the European Commission on joint euro zone bond issuance, calling them "extraordinarily inappropriate."
- French Finance Minister Francois Baroin told a conference in Paris that it was the ECB's responsibility to sustain activity in the currency bloc. "The best response to avoid contagion in countries like Spain and Italy is, from the French viewpoint, an intervention (or) the possibility of intervention or announcement of intervention by a lender of last resort, which would be the European Central Bank," Baroin said.
The disagreement about whether the ECB should issue bonds to replace individual nation sovereign debt is at the core of the debate and at least part, and perhaps all, of the bond market cooling to German bunds. Germany has steadfastly opposed such a role for the ECB, while France has pushed for the action. The low countries, especially Netherlands, have been in the role of intermediary. In an attempt to bridge the divide, European Commission President Jose Manuel Barroso has unveiled proposals for much more intrusive oversight of euro zone countries' budgets and efforts to meet macroeconomic targets, and set out the options for introducing common euro zone bonds.
Reaction to the European Commission proposals were summarized in the following excerpt from Reuters:
"I welcome Barroso's proposals, which are a real step forward on many points," Dutch Finance Minister Jan Kees De Jager said in a statement. "It will, however, still be an uphill battle, for there are those who resist further discipline.
"Eurobonds are not a magic solution to the current crisis and could even worsen it," he said. "We have to do first things first, and that means establishing strict supervision and enforcement of budget discipline."
Another alarm bell for financial markets on Wednesday came when Standard & Poor's warned that credit ratings in the euro zone could come under renewed pressure if large parts of the currency bloc slip back into recession, as expected, next year.
Another round of poor data on Europe's manufacturing and service sectors on Wednesday added to conviction that the continent is heading into another recession.
"With so much at stake, one would expect that some accommodation can be found between euro zone monetary authorities and national policy makers that balances substantive government policy actions with more aggressive steps by the ECB to counter a renewed economic downturn," Beers said.
In the opinion of some the fiddling while the house burned analogy is appropriate. Megan McCardle, The Atlantic, wrote:
A year ago, Germany and France could probably have saved the euro--at least for a time--by stepping in to guarantee all the debts of the peripheral euro zone nations. To be sure, this would have created quite a lot of other problems, but it would have saved their banks and their currency union.
However, a year ago, governments were nowhere near ready to take such drastic action: the French and German governments didn't want to put their credit rating behind Greek profligacy, and their voters wouldn't have stood for it if they'd tried.
At this point, however, with the panic in full flight, it's not entirely clear to me that even a 100% guarantee would staunch the bleeding for more than a short time. Do the Germans really have enough to guarantee the debts of most of the rest of the euro zone?
Before you answer that, ponder the lesson of this crisis (and the Great Depression): bank crises are ultimately sovereign debt crises. Given the size of modern states, and the complexity of modern economies, a broad banking crisis forces the sovereign to step in (and if they don't, it vaporizes so much tax revenue that from the perspective of their creditors, they might as well have).
Effectively, Germany and France and a handful of other tiny countries have to guarantee both the sovereign debt and the bank liabilities of the whole eurozone. Given the holes that recent events have exposed in these systems, can they credibly do that? Even if the Greeks and Italians don't use that guarantee as a blank check to avoid reform?
Editorial note: Whether it is war reparations that can’t be paid or ill advised sovereign debt issued across national borders for which repayment is impossible, the result can be similar. Europe has been here before following World War I. Will the resolution this time be different?
The resources exist to make the outcome much more positive this time, but political forces are fighting hard to prevent an “overall optimal” solution so that their “individual interests” can be optimized. As Derryl Hermutz wrote a few days ago The EU Has a Zero Sum Problem and the component parts are trying to get a larger sum without compromising the “zero,” which is by definition not possible.