Finally: we are all Greece!
OK, not quite. But the news that Germany was unable to sell one third of the new government bonds it sought to auction today is a worrying sign. ‘Investors boycott German government bonds!’ screamed the Handelsblatt headline.
Has Germany joined the periphery, too? Has the core melted?
What has happened, in a nutshell, is the following.
Prior to the crisis all countries of the eurozone paid more or less the same low interest rates when they issued new government bonds, in the region of 4%. Why the same? Because markets perceived them as being essentially the same bonds, carrying the same risk. Why low? Because they represent the safe, ‘benchmark’ asset and so yield a return close to the trend nominal growth rate of the economy (around 2% inflation and 2% real growth).
This changed in the crisis. The rates demanded of peripheral countries shot up, as investors realised that they could lose money on what they had seen as their safest assets. (At the latest with the Greek ‘voluntary’ haircut proposals, make that: lose money big-time.) German rates, though, fell to historically low levels. This reflected both the depressed outlook for nominal growth and, more importantly, a flight to safety by investors, who dumped Greek and bought German bonds. So far so rational.
More recently, though, the rot spread to countries such as France, and even Finland and Austria, countries with rock solid fiscal fundamentals, saw yields rising (albeit only up to what might be considered normal, from abnormally depressed, levels). In response they have rushed to announce ‘tough’ austerity measures and prepare debt brakes that risk intensifying the crisis in the short-run and making sensible economic policymaking impossible in the longer run.
Now, it seems, we have come full circle. At the low interest rates offered, at least, Germany today found itself unable to place one third of the bonds it hoped to sell. At least some investors, apparently, see even Germany threatened. As it is still hard to see what could be an alternative safe asset (US treasuries? I am not so sure), it is likely that, given the very low interest rates, investors are simply sitting on their cash. And waiting.
Some perspective. German rates are, as mentioned, at historical lows. At somewhat higher, but still historically low, rates the bonds will surely be snapped up by investors, given the dearth of alternatives. Still, it is a worrying sign, perhaps a watershed.
Let me draw three conclusions from this story.
Starting with the most general, capital markets, even if they appear to correspond to the textbook idea of a perfectly competitive market, cannot be trusted to send the right price signals. The too-low spreads prior to the crisis worsened underlying structural tensions within monetary union; too-high spreads and speculation are now exacerbating the crisis, indeed pushing it towards an imminent breaking point. Appropriate rules, regulations and institutions are needed.
Secondly, squealing from German commentators and politicians early on in the crisis that Eurobonds and other forms of sovereign debt socialisation would lead to increases in Germany’s interest rates and debt burden were some mixture of ignorant, cynical and hypocritical. Germany has to date been a profiteur of the peripheral countries’ malheur, with regard to its debt-financing costs at least. At an earlier stage implementing any one of a number of eurobond proposals would have decisively helped the peripheral countries, mitigated social and economic hardship, stopped contagion, while not worsening Germany’s refinancing position compared with its initial position.
Now that Germany, too, seems to be affected by market panic, and its economic prospects darken as country after country tightens its belt, killing demand across the continent, perhaps policymakers will finally realise the systemic nature of the eurozone crisis, drop the moralistic debts-are-bad-surpluses-are-good attitude that has driven us from one disaster to the next, and take the long-awaited required measures.
Maybe it will happen. But I won’t be surprised if tomorrow’s media are full of laments that even the virtuous have now been tainted – by virtue of their selfless willingness to assist the southern spendthrifts rather than booting them out of the monetary union. The latest twist in the sovereign debt saga is yet another call to do the right thing, but it may well be misinterpreted and be used as justification to take a different path.