Radio commentary, November 26, 2011

eurocrisis infecting core

The European situation spun more deeply into crisis this week. Interest rates on 10-year Italian government bonds crossed the spooky 7% barrier, yielding 5 points more than comparable German bonds. A year ago, Italian bonds yielded 4.3%, less than 2 points above German rates. In the jargon of the markets, this blowout in Italian spreads is a sign of investor panic.

One-Year Chart for Italy Govt Bonds 10 Year Gross Yield (GBTPGR10:IND)

On paper, Italy shouldn’t be so bad off. Its budget is in decent shape, and Italians have plenty of domestic savings, more than enough to cover the government’s financing needs. (The joke is that Italians don’t pay taxes—they buy government bonds instead.) Sure, the Italian economy isn’t German in its mightiness, but in more normal circumstances, it would be able to continue to put one foot in front of another. But these are not normal circs, of course. Italy is the third-largest economy in the eurozone, the eighth-largest in the world—in other words, a major problem should it blow up, financially speaking. If capital flees Italy and it’s unable to service its debts, then the euro will certainly fall apart. That might not be unreasonable in the long term, but in the short, it would mean more turmoil and more recession. And if banks get scared and stop lending to each other, well, it’s 2008 all over again.

And, as I’m recording this, news came in that Belgium’s debt had just been downgraded by Standard & Poor’s, deepening the anxieties. Belgium is a heavily indebted, ethnically divided country that can’t put together a government, so the downgrade isn’t exactly a surprise—and it does remain at AA+—but the markdown underscores the fact that the crisis is moving from the periphery towards the core of Europe.

Further evidence that the crisis is moving towards the core is that Germany had a rocky bond auction earlier in the week—meaning weak demand for its debt. Though not a failure, it was unnerving that even the Teutonic core is shaking. The silver lining of this is that Germany might finally wake up to the fact that it needs to so some leadership and cobble together some sort of bailout—meaning orchestrated debt writeoffs with German financial assistance—or face total meltdown in the Old World.

good riddance, Supercommittee

Meanwhile, the U.S. deficit supercommission collapsed, unable to come up with anything. Dems were willing to cut Social Security and Medicare, but Republicans wouldn’t agree to tax increases. This is basically good news. It will keep austerity at bay for a little while longer. We do have to worry about the automatic spending cuts that this failure is supposed to trigger—though it’s hard to imagine Congress sitting back and letting those happen. But they would shield Social Security and Medicare and take a reasonable slice out of the Pentagon. That, plus the likely expiration of the Bush tax cuts, would yield a somewhat more progressive result than what this committee was likely to come up with.

But despite the groans of deficit hawks over the supercommittee’s failure, the bond market yawned on the news. In fact, because of the euro crisis, U.S. Treasury bonds now yield less than comparable German bonds. A month ago, the U.S. Treasury had to pay more than its German counterpart. If the so-called bond market vigilantes—remember them?—were really worried about fiscal ruin in the U.S., we’d be seeing our interest rates rise somewhere between gently and dramatically. But they’re not. Nervous capital is fleeing Europe—and not just the periphery, but apparently Germany too—and seeking refuge in Treasuries. So much for the U.S. = Greece scenario.

More on all this next week.

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