Referendum, no referendum. Papandreou’s staying – wait, no, he’s going.
It’s getting hard to keep up with the Greek end of this euro-crisis. It’s like a high-stakes round of the hokey-cokey.
The good news is, you don’t really need to worry too much about exactly what’s happening in Greece.
The bad news is, that’s because there are much more significant things to worry about…
Forget Greece – Italy is the big worry in the eurozone
Greek prime minister George Papandreou has agreed to step down. The country is likely to hold new elections in February. In the meantime, Papandreou and rival parties will try to form a coalition ‘unity’ government that will focus on meeting the eurozone’s conditions to secure a second bail-out package for Greece.
This of course all leaves plenty of room for more nasty surprises from Greece. But there are far bigger problems to worry about now. Greece has always been the canary in the eurozone coal mine. What’s ridiculous is that Europe’s leaders are still trying to give the canary the kiss of life, while the mine-shaft is collapsing around them.
What am I talking about? In short, Italy is now in serious trouble. You may remember that when this all kicked off, the way to tell which country was going to need bailing out next was to look at its bond yields. Once its cost of borrowing hit a certain level, it was just a matter of time before a bail-out was required.
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According to Bloomberg, the real point of no return for Greece, Portugal and Ireland came when the yield on the ten-year bond went above around 6.5%. “After that, it took an average of 16 days for yields to pass the unsustainable 7% level.” You can see a chart showing this on our bonds page.
So the fact that Italy’s ten-year yield is now hovering around 6.6% is really rather worrying. “The acceleration in Italy’s bond yields is very, very frightening”, Gary Jenkins of Evolution Securities told Bloomberg. “It’s surprising how quickly a difficult situation can become an impossible one. Politicians always think they have lots of time, but when the market decides to withdraw support, it can do so very suddenly.”
Stupidity, not conspiracy
Let’s make something clear here. When people talk about ‘markets’ and ‘bond vigilantes’, it sometimes gives the wrong impression. European politicians and left-wing economists would have you believe that there’s a cabal of middle-aged men sitting around in a room, cackling evilly as they ponder which innocent democracy to tear down next.
It’s a bit closer to the truth to suggest that there’s a disparate group of middle-aged men, panicking as they realise that the ‘safe’ government debt they bought might not be the ‘sure thing’ they thought it was. That means their quarterly performance figures and thus their bonuses might be under threat. So they’re selling out as fast as they can get away with.
These guys aren’t trying to destroy the eurozone. Indeed, they’d much rather it held together. That’s what they’ve been betting on all this time. The assumption has been that eurozone politicians would find a solution to all this that would stop bondholders from taking any pain. Having seen ‘haircuts’ for Greek bondholders endorsed, they realise that this won’t necessarily be the case. So now it’s time to abandon ship.
The end game for the eurozone
So what happens next? Europe’s fundamental problem is that no one knows where the buck stops. Investors in British and US debt know that if push comes to shove, their central banks will print money to buy their government’s bonds. This is of course, bad for the currency. But it does mean that they can’t technically default outright.
The European Central Bank (ECB) isn’t yet ready to print money. However, it may end up being forced to. The economist Ken Rogoff is these days widely viewed as the authority on banking and debt crises. Writing on the Project Syndicate blog, he notes that if eurozone countries go bust, as looks likely, the ECB may end up needing to be recapitalised as it loses money on all the cruddy bonds it holds.
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The trouble is, the northern European countries won’t want to pay for the ECB if it goes bust. That will leave the ECB with only one option: to print money. However, as Edward Harrison notes on Credit Writedowns, that would see the euro sink like a stone, and inflation surge. As a result, the inflation-averse Germans would “fork over a wad of cash to top up the ECB’s capital base” – in other words, they’ll pay for the bail-out once the consequences of not doing so become clear.
This conclusion – that one way or another, the ECB will be forced into quantitative easing – isn’t very different to the one drawn by our own James Ferguson, who maps out an end game to the eurozone crisis in the current issue of MoneyWeek magazine: The toxic fallout from Europe’s banking crisis. James also lists some ways to play the crisis. If you’re not already a subscriber, subscribe to MoneyWeek magazine.
But one thing it most certainly means is that the euro cannot remain as strong against the dollar as it currently is. Printing euros, or seeing one or more members threaten to leave the zone, will send the euro lower between now and the end of this crisis. If you have more of a trading mentality, you can learn some tricks and tactics for spread betting currencies effectively with our free MoneyWeek Trader email.
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