What Options Are Left for the Common Currency?

Spiegel
October 7, 2011

Politicians have maneuvered their countries into an unparalleled situation in the euro crisis. And they already know what most voters don't yet suspect. In the end, only two possibilities will remain to save the beleagured common currency: an expensive transfer union or a smaller monetary union. Either solution will be extremely costly. By SPIEGEL Staff

This is the final installment, comprising Parts 3 and 4 of SPIEGEL's recent cover story on the history of the common currency. Be sure to read Part 1 and Part 2 as well.

Act III: The Euro Crisis (2010/11)

How Greece becomes a pawn in the hands of investors. How the European Central Bank goes astray. Why the world no longer makes sense to the Greeks. How the Maastricht bet goes bad.

In October 2009, Marko Mršnik's analysts at rating agency Standard & Poor's computed that Greece's debt would increase to 125 percent of economic output in 2010. On the same day, it became more expensive to hedge Greek bonds against default. The default insurance instruments, known in market jargon as credit default swaps (CDS), were an indicator of how bad things stood for Greece. It was now costing $189,000 a year to hedge a $10-million Greek government bond against default. For major investors, it was a signal to get out of Greece.

A few people had also become nervous at the headquarters of the Pacific Investment Company (PIMCO) in Newport Beach, California, about an hour's drive south of Los Angeles.

PIMCO is by far the world's largest investor in government bonds. The company lends governments money by buying their bonds. When PIMCO stops buying a country's bonds, it's a clear sign that the country is on the verge of crisis and possibly even bankruptcy.

PIMCO controls more than $1.3 trillion (€1.05 trillion) on behalf of its customers. It is an absurd number, even in these times of superlatives, times of bailout funds and banks being supported with billions upon billions in taxpayer money. Though far from a household word, PIMCO has four times the German national budget to invest.

That's why almost all governments maintain close ties to PIMCO. They send their finance ministers, the heads of their central banks and sometimes even their national leaders to see CEO Mohamed El-Erian and convince him to buy their government bonds.

In the last few weeks of 2009, PIMCO sold all of its Greek bonds. El-Erian says the company wanted to get out before everyone else noticed that the numbers weren't adding up. The company never relies on outside assessments. Instead, it employs hordes of analysts, some of whom used to work at the International Monetary Fund, where El-Erian began his career.

The analysts spend all of their time digging through large quantities of data and the financial statements of nations, re-calculating, preparing projections and feeding numbers into computers. When they don't like what they see, PIMCO gets out.

When Greece was accepted into the euro zone, it was one more reason for PIMCO to buy Greek bonds. El-Erian says the sentiment at PIMCO was that if the Greeks were being granted membership in such an elite club, then Athens would follow the rules -- or the government would be severely sanctioned if it didn't. But that didn't happen. Instead, political concessions were made and the rules were ignored. That, El-Erian argues, is what brought the cancer into the euro zone.

So why didn't the financial markets penalize Greece earlier? Why was the same yardstick applied to Greek government bonds as to German bonds, until only a few years ago? Why did the markets continue to buy the country's bonds?

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