August 2011: The euro crisis reaches the core

"Investors are anticipating the unravelling of the 21 July 2011 “solution” and a breakdown of the interbank-market that would throw the economy into an “immediate recession” like the one experienced after the Lehman bankruptcy. This column argues that this will happen without quick and bold action. The EFSF can’t work as designed but if it were registered as a bank – which would give it access to unlimited ECB re-financing – governments could stop the generalised breakdown of confidence while leaving the management of public debt in the hand of the finance ministers.

Canaries were kept in coal mines because they die faster than humans when exposed to dangerous gases. When the birds stopped singing, wise miners knew that it was time to gear up the emergency procedures.

Greece, as it turns out, was the Eurozone’s canary. The canary was resuscitated and a small rescue mechanism was set up to revive a further canary or two – but beyond this the warning was ignored. The miners kept on working. They convinced themselves that this was the canary’s problem.

Greece wasn’t a special case

The problems of Greece should not have been interpreted as a special case. They should have been viewed as the first manifestation of a general problem:

• As a sign that the Global Crisis was spreading to public debt;
• As a sign that capital markets would no longer refinance excessive levels of public debt, especially in the Eurozone members who could no longer rely on central bank support.

This has become particularly clear after the July 2011 European Council – the meeting that was supposed to end the crisis by settling the Greek case with a mixture of lower interest rates and some private sector rescheduling and restructuring.
The Greek public might not appreciate it, but it has received a preferential treatment from the EU. With the decisions taken at the July European Council, Greece will essentially have all its financing needs for the next decade arranged and is assured of paying less than 4 % on the new debt it is incurring. The two other countries with a programme, Ireland and Portugal, will have similarly low interest rates and long-term loans, but they are still expected to face the test of the markets in a few years.

The debt fears reach the core

But while Greece, Ireland, and Portugal got lower rates for their official long-term financing, Spain and Italy experienced a surge in their borrowing costs. They are paying close to 6% for ten-year money..."

at http://www.voxeu.org/index.php?q=node/6853