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Euro Bond Markets Are Drowning, Not Waving

Yields on Spanish and Italian bonds dropped sharply as the European Central Bank bought them heavily today.  That means we won’t get a total financial meltdown today.  This is good news for all of us, and not just for the many hedge fund managers and Swiss bankers working night and day to keep the vast Mead network of trusts and investment vehicles at their customary 20 percent annual growth.

But this isn’t progress.  It’s more like Pharaoh’s dream in which the seven lean cows ate up the seven fat ones but stayed as skinny as before.  The bad credits in the world system are inexorably contaminating the good; as the ECB buys weak Spanish and Italian paper at above market rates, the creditworthiness of the ECB and its backers (at this point primarily Germany and France) inexorably weakens.  The effect is trivial when dealing with small economies like Cyprus and Greece, but Italy runs in a different league.  The Royal Bank of Scotland estimates that the ECB could end up buying $1.2 trillion in bonds, more than ten times the amount spent so far.

A sign of future trouble: investors are starting to demand higher interest rates for German government bonds.  Germany is either going to get stuck holding the bag for Italian debt or its economy will take a big hit as the euro breaks up, Germany’s new currency soars, and German exports are priced out of world markets.  Quite possibly the Germans will get the worst of all worlds: a big debt from supporting Italy followed by a euro crash as the rescue package fails.

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  • thibaud

    This is bad news for the US, though not necessarily for the frugal, fiscally-responsible, social democratic nations of the former Hanseatic League region. One might not know it from Mr Mead’s recent lunge in to apocalyptic fear-mongering, but the heavily interventionist economies of Germany and Sweden (and Canada’s) are booming. They all have low debt, healthy government finances, well-run companies and well-educated and productive workers.

    If the publics of Germany, Holland and Finland refuse to mortgage themselves for the next couple of decades to bailing out the PIIGS, then the Eurozone will shrink to comprise basically the Hanseatic League nations plus France. While in the short run a devaluation of Greek, Italian, Spanish, etc currencies may help say, Fiat compete with Volkswagen in export markets, Germany will retain its healthy growth trajectory and sound public finances.

    There’s indeed a lesson here, though it’s not necessarily the one Mead wants to extract: the “blue-state” model isn’t necessarily broken. It depends on several things that Germany, Canada and Sweden have, in spades, and that our current political economy lacks:

    1) a tight rein on bankers, via high and serious capital requirements and separation of prop trading from the core business of lending to companies, households and consumers;

    2) relatively clean and transparent politics

    3) a culture of frugality, of doing more with less, of business moguls who accept high tax rates and who focus on actually MAKING STUFF rather than arbitrage and asset-flipping;

    4) a dual-track educational system that favors vocational training from an early age so that you build a society where everyone has a valued trade, where, as Hans Magnus Enzensberger puts it, “nobody is a nobody.”

    5) an intelligent, points-based immigration policy (Canada does this well; Germany, less so) that favors immigrants with advanced skills and capital and that keeps out illiterate dropouts, however hard-working they may be.

    Yes, we can have growth as well as social solidarity, as the nordics and Canadians might put it, and fiscal responsibility as well. But we don’t need to repent our cleanse our souls to do it. We just need to follow the lead of the Germans, Swedes and Canadians, and rein in our bankers, bring back vocational ed, and stop importing an underclass.

  • Kris

    The reason Canada is in relatively good shape today is that roughly two decades ago, it embarked on a bipartisan effort to get its financial house in order, which included reining in government expenditures. This only occurred after the bond markets put the fear of God into enough politicians.

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