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The people
buying bonds issued by Italy and Spain are clearly looking past the
dysfunctional balance sheets and focusing on Germany's reluctance to let a major
PIIGS country default. So an Italian bond, in the mind of the market, becomes
a German bond.
But this
sword cuts both ways. If European debts are tossed into one big communal pot
with everyone responsible for everyone else, then buying a German bond is the
same thing as buying an Italian bond -- since German taxpayers are ultimately
on the hook for both. Viewed that way, lending money to Germany for ten years
at 2% is hardly risk-free.
Which is why
the failure of Germany's most recent bond auction is so interesting:
German Bonds Fall Prey to Contagion
Nov. 26
(Bloomberg) -- European bonds slumped after Germany failed to draw bids for
35 percent of the offered amount at an auction of 10-year bunds,
stoking concern the region's debt crisis is infecting even the safest
sovereign securities.
Thirty-year
German bonds slid, with yields rising the most since the week through Sept.
3, 2010, amid concern Germany will need to offer greater financial support to
its euro-area peers. "Non-residential investors are increasingly
troubled by events," said Eric Wand, a fixed-income strategist at Lloyds
Bank Corporate Markets in London. "It was ignited by the 10- year bund
auction result showing further credit dilution, and hasn't been helped by the
outcome of Italian sales."
Thirty-year
German bond yields rose 21 basis points to 2.83
percent at 4:54 p.m. London time yesterday, from 2.61 percent the week
earlier.
Total bids at
the auction of German securities due in January 2022 amounted to 3.889
billion euros ($5.15 billion), out of a maximum target for the sale of 6
billion euros, sparking concern that the turmoil emanating from Greece's debt
crisis now risks engulfing the region's biggest economy.
And last week
was just the warmup for next week's deluge of new
borrowing:
Italy Leads Busy Week of Euro-Zone Bond Sales
FRANKFURT--Italy,
Belgium, Spain and France all plan to sell bonds next week, a big test for a
region still reeling from unexpectedly weak demand for debt from its German
core.
Given the
surge in bond-market yields in recent weeks, all four countries are expected
to pay considerably more for cash than they did at their previous auctions.
Just how much higher the tab turns out to be will indicate the extent to
which investors are giving up on the ability of politicians to take tough
measures to reduce their debt loads.
All told,
five euro-zone governments are together expected to sell about €19
billion ($25.36 billion) in debt next week, more than double the amount three
governments sold this week.
Italy will
offer up to €750 million in 2023-dated inflation-linked bonds on
Monday, followed a day later by up to €8 billion in debt maturing in
2014, 2020 and 2022. The sales come after the country on Friday paid 6.5% to
borrow six-month funds, nearly double the 3.5% it paid only a month ago, and
its bond yields again soared, to worrying levels solidly above 7%.
Meanwhile,
the shape of the bailout is becoming more clear:
IMF Readying Loan of as Much as $794 Billion for
Italy, La Stampa Reports
The
International Monetary Fund is preparing a 600-billion euro ($794 billion)
loan for Italy in case the country's debt crisis worsens, La Stampa said.
The money
would give Italy's Prime Minister Mario Monti 12 to
18 months to implement his reforms without having to refinance the country's
existing debt, the Italian daily reported, without saying where it got the
information. Monti could draw on the money if his planned
austerity measures fail to stop speculation on Italian debt, La Stampa said.
Italy would
pay an interest rate of 4 percent to 5 percent on the loan, the newspaper
said. The amount could vary from 400 billion euros to 600 billion euros, La Stampa said.
Huge week coming up
It's no
surprise that a new bailout is announced today. Without a compelling
distraction, the markets would fixate on upcoming bond sales and would
probably demand even higher rates, effectively bankrupting the PIIGS
countries and hobbling Germany and France. So something big has to happen,
and right away.
The
International Monetary Fund, meanwhile, isn't some independent government
with farms and factories and oil wells that it can tax to fund its foreign
aid activities. It's just a bank, sort of, holding deposits from the US and
other formerly rich countries, which it then lends to supposedly poorer ones.
So an IMF loan to Italy is in reality a US/German bailout. There is no free
lunch, there is no extra money sitting around. Everything the IMF has comes,
directly or indirectly, from the printing presses of safe haven governments.
And the
soon-to-be-announced 600 billion euro bailout is just for Italy. Since Spain,
Ireland and Portugal between them owe just as much and are just as functionally
bankrupt, expect them to get as much or more in coming weeks.
Which brings
us to the nature and function of money. This game is only possible while the US and Germany
have currencies with relatively stable values. Should the dollar and/or euro start
to fall, then loan guarantees denominated in those currencies become a lot
less attractive. Bond prices will fall
commensurately, and the owners of those bonds will have massive losses that
they'll have to acknowledge one way or another. The result: zombie banks that
can't afford to lend and underfunded pensions that can't meet their
obligations -- and the need for even bigger bailouts.
That's why
this week is so huge. If investors realize that German bonds are really
Italian bonds, they'll demand higher interest rates from all involved (and we
should be short the major stock indexes). And if investors realize that the
IMF is just the Fed/ECB in drag, they might finally lose faith in those
banks' currencies (in which case gold and silver will soar). In either case,
it's game over for the current system.
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