"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

Friday, November 12, 2010

Ireland Using a Page From Greece's Playbook: Blame Germany

No, this doesn't involve World War II reparations of any sort, but a recent comment by Angela Merkel that bondholders of sovereign debt should also feel pain. To date, it's been the balance sheets of central banks and governments that have suffered, while private sector bondholders have been effectively bailed out. I have covered this topic in my post: PIMCO's El Erian does not believe EU bailout of periphery is a success, and what Michael Hudson has been saying all along.

What I described in that post was that the EU "bailout" fund created earlier this year was really providing the bondholders with an exit strategy - so Banks and Wealthy investors (as well as Pension Funds) could be protected, or at best, given some time to wind down their holdings.

Now that comment by Merkel is being blamed for scaring the bond market, and creating an unstable environment.  To be fair to Chancellor Merkel - I agree with her comments.  But nonetheless, they have created an unintended consequence of rattling investors and pushing up bond yields. 

From the Telegraph:
Concerns Ireland will require an International Monetary Fund-EU bail-out helped push yields on 10-year Irish Government bonds up to around 9pc, a record, as investors demanded higher returns to shoulder the risk.
Markets worry whether Ireland will be able to pay its debts, given its costly bank bail-out, weak growth and a huge budget deficit of 14.4pc of GDP, the eurozone's highest.
British taxpayers took a hit as shares in Royal Bank of Scotland fell 2.7pc to 41.02p on fears over the state-backed bank's exposure to the Irish market through an estimated £50bn of loans. One source said some traders were using the bank as a proxy to short Ireland.

... The market nerves pushed the spread between Irish 10-year bond yields and German yields to well over 6 percentage points, a new record. The cost of insuring Irish debt against default also hit a fresh high.
"The bond spreads are very serious and there is international concern throughout the eurozone about that," said Mr Lenihan, adding he would look for clarification of the German plans. He also tried to reassure that comments from Ireland's central bank governor – that IMF austerity plans for Ireland would not differ greatly from Dublin's – were not laying the ground for aid.

Germany has indicated the proposals would not apply to existing debt, but fears over potential losses are high after France said on Wednesday that investors must share in the cost of safeguarding debt.
German Chancellor Angela Merkel argued on Thursday that taxpayers could not keep being told they "have to be on the hook for certain risks, rather than those who make a lot of money taking those risks."

... Irish yields are now well above the levels Greece faced just before it saved from defaulting through a €110bn (£93bn) loan in the spring, according to Capital Economics.

"The most likely outcome now is that Ireland will need to receive assistance from the EU/IMF," said Gary Jenkins at Evolution, who estimated a funding requirement of around €43bn over two years.
Full article HERE.

This doesn't bode well for the EU or the Euro.  It wasn't that long ago that Ireland was being hailed as a protoype of successful austerity measures.  Regardless of Merkel's comments, I believe that Ireland has yet to fully deal with the amount of credit in its economy.  In a debt based system, cutting back government expenditures while the private sector delevers amplifies the deflationary forces.  To put it another way:  Money is created thru debt creation/lending, so less government spending/money creation = less money in the system to pay down debts and interest = debt default/destruction = money destruction.  It's a vicious cycle and no one knows where the bottom truly lies.

These fresh fears also explain the recent rise of the dollar in Euro terms, despite the Fed's recent QE2.  

No comments: