Contagion
Nov 20, 2011
Posted by Jody Eisenman | Filed under Uncategorized
It now appears that the crisis in Europe us spreading. As the ECB continues to fiddle, the rest of Europe is beginning to burn. The yields on Spanish bonds have jumped to almost 7% on their last ten year auction, as compared to 5.43% less than a month ago. French and Belgian yields are rising as well. Since the start of the ECB bond-buying program in May 2010, the ECB has purchased €187 billion of government bonds; which still has not prevented Italy and Spain from passing the critical threshold.
As I have written earlier, the issue in a nutshell is that Europe has way too much sovereign debt. The strategy among European countries has been to overspend their revenues, and then borrow more and more to finance it. This strategy has “worked” only because investors were willing to buy their bonds, and rates have remained relatively low. Now, rates are rising, which causes a multitude of problems. In simple terms, it means that even more of their expenses must go to pay the interest on their ever increasing debt. In order to try and keep rates in line, the ECB has been buying bonds. For a variety of reasons, this hasn’t worked. The total losses have been estimated at anywhere between 1 and 5 trillion. Now who owns these bonds? Mostly, European banks, especially those in France. Remember the US bank crisis in 2008? When your bank is allowed to leverage its’ balance sheet at 30 or even 40 to 1, it doesn’t take much of hit to your portfolio before you are bankrupt. This is what happened to Lehman Brothers, and is now possibly happening to several major European banks. The ECB’s method for dealing with this crisis is to quarrel among its’ members. At the end of the day, bailing countries out with billions of additional debt will only postpone the inevitable. In other words, unless countries begin to not only spend within their needs, they must run a surplus in order to gradually reduce their debt. If this does not happen soon, we are going to be looking at a very unpleasant ending.
