Jeff Harding

The Scarlett O’Hara Approach To Solving The Eurozone Crisis

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“The rise in the [Spanish] 10-year yield well beyond 7% carries a very distinct reminder of events in Greece in April 2010, Ireland in October 2010 and Portugal in February 2011,” said analysts at Bank of New York Mellon. “In each case, a decisive move beyond 7% signaled the start of a collapse in investor confidence that, in each case, led to a bailout within weeks,” they added.

Yesterday the headlines were that Spain’s 10-year bonds hit 7.51% and they raised questions about the Eurozone’s ability to bail out Spain and its banks. Today the rate hit 7.64% so the markets weren’t phased by the assurances of the various government and financial leaders that the situation was not out of control. Now the fear is that Italy will be next—their bonds hit 6.62% today. FYI, Greece is at 28.01%. Bunds are 1.23%. Apparently Spain 5-year bond yields are reaching the level of the 10-year paper, which is not exactly a vote of confidence.

Spain’s sovereign hole is now estimated to be about €100 billion if you include the liabilities of the various provinces for which Madrid is on the hook.

Spain’s finance minister, Luis de Guindos, said that the ECB should help. What he means is that they should buy Spanish paper. In other words, a direct monetization of their debt.

Moody’s gave Germany a slap on the wrist by issuing a “negative outlook” because of the potential bailout burden on them for Spain and Italy. As well, they were concerned with the state of German banks and the bailout cost for that. That’s what sent down the markets on Monday.

Markit’s latest data for the EU and the Eurozone was also disheartening as they cited:

Fitch came out with a negative report on global economic growth today and noted the problems in the Eurozone:

The crisis took a further heavy toll on ratings in H112, as Fitch downgraded six eurozone sovereigns by a total of 16 notches (12 excluding Greece). Spain was particularly hard hit by two multi-notch downgrades (totalling five notches), taking its rating to ‘BBB‘. In March, Greece set a record EUR199bn sovereign default, the first by an advanced country in the modern era. Among other developed countries, Fitch in May downgraded Japan – the world‘s third-largest economy and second-largest debtor (in dollar terms) – to ‘A+‘/Negative Outlook.

It is hard to find anything positive coming from the Eurozone. Here are today’s headlines from the Wall Street Journal’s “European Debt Crisis” column:

Italian Leader Tells Sicily to Tighten Spending

Europe Dims German Outlook

Euro-Zone Business Output Falls

Spain Bans Short-Selling on Stocks

Greek Leader Seeks Backing for Overhauls

Spain’s Economy Contracts

Euro-Zone Business Output Falls

Euro-Zone Government Debts Hit Record

You might not believe the official statements or Moody’s or Fitch’s assessments, but you can believe the bond vigilantes who put up money when they speak.

I see no credible plan for saving Spain at this point. If Italy’s debt costs also pass the 7% bar, then there will be some serious ganging up there as well and yields throughout the Eurozone will spike. The question is: can they contain it? My question is: how? There isn’t enough money to bail out Spain, much less Italy, plus the banks that will collapse—remember Eurozone banks are allowed to mark Eurozone sovereign bonds at par, not market, for purposes of their Tier 1 capital requirements; what faith will anyone put into them if their capital is not real?

What is the alternative and what will Germany do?

The answer seems rather obvious that these sovereigns will wither issue bonds that the ECB will cover (debt monetization). This could take several forms that have been discussed in the past, such as ECB guarantees of sovereign or some entity created by sovereigns such as the European Stabilization Mechanism (ESM)/European System of Financial Supervisors (ESFS) system or some other entity whereby the bonds issued are backed ultimately by the ECB. If they are desperate, the ECB will just step in and buy sovereign bonds to prop up the market (LTROS). It’s complicated.

It is highly likely that the Germans’ resolve against money printing will dissolve in the face of panic. They know they are the penultimate funders of last resort for any mechanism that doesn’t involve the ECB, so perhaps they will see the short-term advantages of fiat money, give in, let the ECB, the funder of last resort, do its thing, and cross their fingers.

Will that really solve anything? No, it just papers the problems over, but it does the one thing that politicians really like to do: delay the inevitable. Inflation, as they see things, is less threatening than serial bank collapses. As Scarlett O’Hara said, “Tomorrow I’ll think of some way …  after all, tomorrow is another day.”

Copyright © 2012 · The Daily Capitalist

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