Financial Times
November 22, 2011
Investors are increasingly loath to trust the debt of many eurozone sovereigns. That is the most important lesson of recent events. Many European politicians wish to declare war on the markets. They need to remember that they want people to buy their debt.
As of Monday, spreads over German bunds were more than 60 basis points (0.6 percentage points) in Finland and the Netherlands, 152 points in Austria, 155 points in France, 292 points in Belgium, 466 points in Spain, 480 points in Italy, 650 points in Ireland, 945 points in Portugal and 2,554 in Greece. For most members, such spreads are manageable. Even Italy and Spain could live with current yields for a while, albeit not indefinitely. What is worrying is that stresses in eurozone public debt markets are rising: Ireland is the only member to have had a significant decline in spreads, though to what is still a penal level.
There are three explanations.
The first is that investors realise that a number of eurozone countries are at a far greater risk of insolvency than previously thought.
The second is that eurozone sovereigns lack a true lender of last resort. They are what Charles Goodhart of the London School of Economics calls “subsidiary sovereigns”. Their debt bears a risk of outright default rather than mere monetisation. Fearing default, investors create illiquidity, which turns into insolvency. The greater the proportion of foreign creditors, the more plausible default becomes: investors know that politicians are more unwilling to default to their own citizens than foreigners. But, as a result of the currency union, foreigners hold a higher proportion of sovereign debt than before: half of Italian public debt is held abroad.
The third explanation is that there is break-up risk. No currency union is irrevocable. Even countries do not survive forever. But a currency union among discordant states is far more fragile than a country.
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