Time makes fools of us all. Just two weeks ago European leaders met for the tenth time to finally sort out the mess Europe’s economies have found themselves in. Europe’s leaders thought that by extending the remit of Europe’s rescue fund, the EFSF, they would be given a summer break of two or three months. In fact they got two weeks. Why?
The markets have become increasingly worried about Spain and Italy. These two nations have had a hard time borrowing on the sovereign debt markets recently. Sovereign debt works like this. Ireland, say, issues a bond. A bond is a piece of paper that says if you give me 100,000 euros today, I’ll give you back 105,000 euros in five years’ time. The yield, in this case 5%, is the rate of return you can expect if you hold a bond until it until it is repaid or ‘matures’.
The yield required will go up, and the maturity of the bond will go down, if you as an investor think the country has a higher than normal risk of defaulting, which is French for you not getting your money back.
We are now seeing Spanish, Italian, and Belgian yields rise, much in the same way we saw rises in the cost of borrowing for Ireland, Portugal, and Greece. This is happening because growth prospects in these economies are looking poor. If a country doesn’t grow faster than it racks up debt, that is a sure sign it will need to be rescued by other nations, or have to default. So the markets are worried.
The US economy is showing signs of being in dire straits as well. The number of new jobs created is way down, the debt ceiling has signed the US up to painful austerity measures. When you read ‘austerity’ anywhere, remember that it is French for higher taxes and lower levels of public service provision. So your disposable income will go down. Your discretionary spending will go down, and the economy, which is just the sum of your consumption, investment, and government expenditure, will go down. Those are some of the fears plaguing the markets.
US stock markets are also reflecting the fear that the highly indebted US economy might at some point have to default on its debt. We are seeing a ‘flight to quality’ as investors move their money from risky stocks and equities to safer currencies, commodities and precious metals. So we are seeing huge demand for Swiss Francs and the Swedish Krona, the price of gold has skyrocketed. Other markets getting really hammered: the main Spanish and Italian stock markets are now down over 25% from recent highs.
One caveat over ‘the markets’: We have a tendency to treat them as omniscient in Irish public discourse. The reality is ‘the markets’ are mostly 26-year-old eejits that couldn’t locate Portugal on a map most of the time. These young men and women are driven by sentiments like greed and fear, and they tend to herd together in the ups and downs of the business cycle. Much of the turbulence we’ve seen this week is rich people moving their money around, and nothing more. So be calm. The average Irish person reading should not be worried about these developments. They have happened before, and will happen again. The only slight worry might be a demand for harsher austerity measures from Ireland in the future, but that is unlikely given the scale of our austerity programmes right now.
The Eurozone crisis can be solved via a combination of selective and painful debt write-downs on bondholders, and the introduction of Eurobonds to buy vast swathes of bad debt in Europe’s banks and governments to heal their balance sheets. Eurobonds are bonds issued by the EU and guaranteed by the member states. Germany opposes to any use of jointly guaranteed eurobonds, because bond issuance on this scale would put the triple A ratings of Germany, France and the Netherlands at risk. The credit ratings of Ireland, Greece, and Portugal are of course, junk.
The introduction of Eurobonds will allow countries to grow, but may product inflation, which the European Central Bank hates, and which harms those on fixed incomes, like the poor and the old. They may also increase the funding costs for nations. But none of this is clear because the proposals for Eurobonds have not been brought into the light just yet.
The requirement for a Eurobond issuance and senior bondholder burning requires leadership and genuine pan-European thinking on behalf of Europe’s leaders. They have shown themselves masters of can-kicking, as the tenth and eventual eleventh and twelfth crisis summits show. They need to reinvent themselves. We in Ireland need to calm down and let them do it. All of this turmoil in Spain and Italy has happened before. You, the reader, have lived through it just last year. And you’re still here. So chill.