By Mike Whitney
“We are caught, it seems, in one of those self-reinforcing loops that almost always presage a collapse.” – Michael Pettis, China Financial Markets
Germany’s “failed” bund auction on Wednesday was a real gamechanger. It means that Europe’s biggest and most powerful economy will not escape the contagion that’s swept across the south. Germany’s borrowing costs will rise and it’s finances will be put under a microscope. But that’s just the half of it. What’s roiling the markets is that investors are now pricing in the probability of a eurozone breakup. That’s what all the commotion is about; the nightmare scenario is beginning to unfold.
Here are the facts: Of the €6 billion in 10-year bonds that were offered at Wednesday’s auction, only €3.6 billion were purchased leaving the Bundesbank with the remaining €2.4 billion, which is 39 percent of the total allotment, the highest ratio on record.
The auction was, in the words of one trader “a complete disaster” mainly because it showed that Germany is not the safe haven that many thought it was. German debt has become a “risk asset” overnight just like that of Greece or Italy. (although to lesser degree) Investors are fleeing Europe altogether and moving their money into Gilts and US Treasuries. Take a look at this from the Wall Street Journal:
“Euro-zone leaders say they are determined to save the single currency. But the smart money is voting with its feet. First, short-term U.S. dollar-funding markets effectively closed, then the senior unsecured-bond markets shut down, then the interbank market. Now, corporate customers appear to be withdrawing their deposits from some countries’ banks. With an estimated €1.7 trillion ($2.29 trillion) of funding to roll over in the next three years, the stresses in the euro-zone banking system look doomed to get worse….
If eurozone leaders are serious about saving the euro, they must find ways to persuade the smart money to stay.” (“Europe’s Smart Money Votes With Its Feet”, Wall Street Journal)
So, the eurozone is experiencing a bankrun, only, so far, much of the money has merely shifted from the weaker countries to the stronger. Now that’s beginning to change. But don’t be deceived, the problem isn’t Germany’s debt-to-GDP ratio or its prospects for future growth. The problem is that it’s linked to other teetering sovereigns in a single currency suicide pact, and there’s no way to get out unscathed. Here’s an excerpt from the Guardian:
“Global investors headed for the eurozone exit on Thursday after leaders of the area’s three biggest economies squashed residual market hopes for a huge intervention by the European Central Bank (ECB) to solve the sovereign debt crisis….
Angela Merkel again ruled out any expanded role for the ECB and stamped down proposals for single, eurozone-wide “eurobonds” to share the risk of sovereign debt. The ECB, she said, was only responsible for monetary policy….
Merkel … agreed only that early agreement to boost the EU’s bailout fund, the European financial stability facility, could help resolve the immediate crisis…She reiterated the view she expressed to the Bundestag a day earlier that eurobonds or the collectivisation of sovereign risk were neither “necessary nor appropriate” and could function only at a later stage of fiscal union.” (“Fear sweeps markets as Germany rules out ECB intervention”, Guardian)
Merkel’s rejection of eurobonds and fiscal transfers is a death warrant for the eurozone. She also refuses to allow the ECB to act as lender of last resort which would stem the flight out of government bonds. Here’s what a senior trader at a US bank told the Financial Times:
“We are now seeing funds and clients wanting to get out of anything that is denominated in euros and that includes Bunds because they don’t know what will happen to monetary union.”
See? Germany may be an industrial powerhouse and have it’s house in order (economically), but that’s not going to matter if the capital flight continues. It will face the same excruciating reckoning as the others.
So, what’s the solution?
In truth, there are only two options; either move towards total political and fiscal integration (A United States of Europe) or scrap the euro-project altogether and dissolve the union. If policymakers continue to procrastinate (“the politics of dither”), then the market will impose its own solution which will involve a cascade of bank and corporate defaults, soaring unemployment, agonising deflation and a decade of severe depression.
So, is there any chance of a positive outcome to the EU debt crisis? Here’s how economist James Galbraith answered that question:
James Galbraith: “No, I don’t think so. To get there you would have to have a complete reversal of the ideas that presently govern Europe. You would have to have a much greater sense of solidarity, a greater willingness to put European funds into the periphery in a serious and sustained way, and you’d have to have a plan for their growth and development. None of those are presently in the offing.” (Daily Ticker)
EU leaders haven’t changed their minds about anything. In fact, they’ve rejected every idea that might have helped, which is why the eurozone will not pull out of its death spiral.
For the video of Galbraith see link: