Wednesday, November 24, 2010

The Bond Market speaks

James Carville, President Clinton's political strategist once famously said "I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody."

The European Union is now not only intimidated, it is actively terrified.

The Irish bail-out is breaking down.

The fact is that the blanket guarantee which the Fianna Fail government offered the banking system has bankrupted the country. Even despite a slash-and-burn budget, there is just not enough money to avoid a Sovereign default. The costs of the bail-out are now approaching €100 billion, which is now nearly three quarters of the total Irish GDP. The Irish deficit next year will be over 30%.

Meanwhile Portugal is facing a general strike.

CDS spreads for Ireland, Portugal, Spain and now Belgium are hitting new record highs.

A Sovereign default is now odds-on in the next three months, and the likelihood is that if one state defaults, then three or four or even more countries could go under.

The Great Depression of the 1930s did not start in Europe with the Wall St. Crash, it began with the bankruptcy of Creditanstalt in 1931. I fear that the European Sovereign defaults could be the Creditanstalt moment.

The policy makers are staring down the barrel of a gun. The bond market no longer believes in the ability of the EU states to act in concert to avoid a Euro member state defaulting: there simply is not the fire power to guarantee anything more than the smaller economies, so Greece, Yes; Ireland, Maybe; Portugal, possibly; Spain, very unlikely; Belgium, almost certainly not.

As I repeatedly say on this blog, the crisis is not a currency crisis, it is a structural crisis and only radical structural reform can solve it. The failure, over decades, to tackle the structural sclerosis in most European economies is now forcing a moment of truth.

The UK may have gained a breathing space because it has been able to devalue Sterling, but in fact it faces precisely the same problems. If the crisis takes a further turn for the worse, then the UK may be forced into even more drastic cuts than are currently contemplated by the Coalition. Years of unfunded welfare and pensions, mis-allocation of capital, government waste and extravagance, and the whole litany of missed opportunity and failure to reform, is now coming back to haunt us.

It is going to be a rocky ride over the coming weeks.

1 comment:

Liberal Eye said...

We are, as you say, awash with debt and governments - all of them - have long been just kicking the can down the road with such palliatives as periodic devaluations.

Well, we are now at the end of the road. Even where possible, as in the UK, I suspect that devaluation now faces sharply diminishing returns.

As Michael Hudson points out "Debt that can't be repaid won't be repaid". The first problem is how to manage that process with minimum distruption. The next is
discovering how to run the economy in an sustainable way.