The widening European sovereign debt crisis
Euroland is coming apart at the seams. Belgian/Bund spreads are now also over 200bps along with Italy and Spain. Belgium has just entered the periphery and France is not far behind.
Right now there are four to five separate groups in Euroland’s sovereign debt crisis. First, there is Greece, assumed by everyone to be insolvent and the only country to default via its bailout package which reduces creditor repayments by 21%. Then there are Ireland and Portugal. These two countries have also received bailouts but have not defaulted. Next are Spain and Italy, what I have called “the new Ireland and Portugal”. These two countries are seeing their spread to German bunds widen considerably and yields explode above 6%. Fourth is a new and worrying development with Belgium and France becoming untethered from the core. Spreads are widening for these two countries in a way which is dangerous. Finally, there is the core of Germany, Finland, Austria, the Netherlands, Luxembourg, Malta, Slovakia and Slovenia. Estonia and Cyprus are special cases: one is new to the zone and the other has unique problems that I won’t discuss here. That’s 15 countries in six distinct categories (plus Estonia and Cyprus).
Greek, Irish and Portuguese yields have calmed due to the latest bailout. Spain and Italy are now on the hot seat. But my main concern is not Italy and Spain; it is Belgium and France.
This morning FT Alphaville quotes Divyang Shah of IFR Markets:
The 10-year spread on France/Germany has widened out beyond its July peak to its widest level since mid-1990. The 10-year spread on Belgium/Germany has broken through 200bps and currently at 203bps is close to breaking its record wide level just under 215bps from early 1999. Both are significant, but especially so the moves seen in France. It suggests that investors no longer regard it as part of the core and have been for the last few weeks trimming exposure.
Welcome to the periphery. And note that Belgium is now also over the 200bps spread to Bunds that I had said the ECB should target as a maximum for Italy.The problem here is that as more and more countries keep getting plucked off and put into the penalty box, there are fewer and fewer players left to skate. Once France has difficulties, the core only has one country i.e. Germany which is a truly large economy. In my view, that is the end of the line.
Was this inevitable? Well, here are a few thoughts about the euro crisis and the psychology of change from fourteen months ago saying it may have been:
When was the last time an unsustainable economic situation was solved without a crisis? Seriously, that’s a question. I can’t think of one. The way I see it, politicians are always focused on the short-term and that invariably means kicking the gas can down the road until it catches fire and you have to call in the fire department…
But now that it has gone pear-shaped, the EU has repeatedly tried to get through this crisis by making little fixes and tweaks without addressing the fundamental problems of excessive sovereign debt on the one hand and bank undercapitalisation on the other. They have their heads buried in the sand. Instead, politicians have argued that markets are acting like a speculating pack of wolves and creating crisis where none exists. Look at Jeffrey Sachs’ comments in the clip I showed you with Hugh Hendry and Gillian Tett. That’s the kind of rhetoric you see. Well, the wolfpack is at the door and they are going to rip the Euro house to shreds unless the bank capitalisation and national solvency issues are addressed without trying to socialize the losses across the entire euro zone.
This is pretty much the view that Pippa Malmgren took when talking to CNBC Europe last week about the European sovereign debt crisis…
Here’s what you should take away from her comments:
- On kicking the can: "If you’re going to make a bet on the European banking system which is purely based on the idea that policy makers will consistently bail them out, then you have to ask questions about the capacity of policy makers to deliver on that promise."
- On markets as a pack of wolves: "That is fine as long as the market doesn’t call their bluff… Do I think the markets are going to call their bluff? The answer is yeah, because that’s what markets do."
- On the psychology of change: "The thing is, in markets and politics, you have to have a crisis to get a solution. That’s the way it works. It always works this way."
I would suggest the capacity of policy makers to deliver on that promise is now exceedingly low. Either we get the ECB in here to provide liquidity while the Euro’s structural deficits are worked out or the game is over.
Note: This post has been changed to use Estonia in place of an earlier erroneous reference to Lithuania as part of the euro zone.