“In seafaring, there is a concept called the "free-surface effect". It happens when a surprisingly small amount of fluid can move freely inside a boat.
It is an accident waiting to happen. As the boat tilts in the waves, the water starts to flood across the floor, pushing up against the boat's lower side. Instead of righting itself again, the boat begins to list more and more as the water moves inside it, until the boat capsizes. Something similar is happening to the euro”
The problem started when the euro was formed in 1999, governments share a single currency but not a single debt market, which created the problem we now face today.
Market 101: If investors fear default they sell their bonds. As a government can normally "quanatively ease" they can always finance their debts which, however, is not true in the Euro zone where ECB bosses have prohibited the printing press. Therefore people move to self-governing monetary systems (GBP, JPY, USD etc). With these currencies the investor sells the currency reducing the value of the currency, which has the knock on effect of making the economy more competitive and increasing X (exports) for the country. This can not occur in Greece as when you sell the bond you're not selling Greek drachma your selling the Euro used in the 21 nations, which means Greece does not become more attractive to external buyers.
“Just like the seawater inside a boat, liquidity - investor's cash - can move freely within the euro from one government's bond market to another's. And that made the value of Greece's bonds plummet.”
The problem however is much greater, if this can happen to Greece it can, and might, happen to larger Spain and Italy. Investors already fear the same could happen in Italy, so as with Greece investors are flooding out of Italian bonds and into German “safe” bonds. This has pushed Italian interest rates to 6.05% , Germany is currently sitting at 0.25%, a real case of why there is an argument for counter-cyclical measures. When its bad for a country it just get worse and when its good (Germany) it just get better, as their borrowing rate is below inflation so people are actually paying for Germany to borrow money.
The real problem comes when Italian debt costs increase above a point of no return (c 7.5%) where the debts are increasing quicker than growth in the economy, which means they will on longer be able to service their debts and be in much the same situation as Greece.
This story is very similar to the bank runs of 2008, once one becomes stressed the next does and so on and so on. The word everyone seems to be using is this time “contagion” rather than “sub prime” or “toxic debt”
“The best solution would be to have created a single Eurozone government bond market in the first place. Too late for that, even if the Germans hadn't ruled it out anyway. The Eurozone instead hopes that its soon-to-be-1tn-euro bailout fund will do the job.
The fund is like a pump that will try to shift liquidity away from the dipping side of the boat (Germany) back towards the rising side (Italy and Spain).”
Keynes would call for interest rate cuts and allow for QE much like JPN, US and UK have done and increase government spending, even if this means Germany spending a lot more which is something the German’s don’t agree with, but they may have to change their minds before the boat rocks to much and everyone ends up with German bonds in a currency that has capsized/sunk…..
OF
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