The Euro is Already Gone

Today I read an article about the fact that the German government can issue debt with a negative yield.

Germany sold six-month treasury bills at a negative yield for the first time amid demand for the debt securities of Europe’s biggest economy as a haven from the sovereign debt crisis roiling the region. The government auctioned 3.9 billion euros ($4.98 billion) of securities maturing in July at an average yield of minus 0.0122 percent, the Federal Finance Agency said in an e-mailed statement today. It was the first time it sold the securities at a negative yield, Joerg Mueller, a spokesman in Frankfurt, said in a telephone interview. The Netherlands sold 107-day bills at minus 0.007 percent on Dec. 12.

Thus purchasers are paying the German (and Dutch) governments for the privilege of lending them money.

Meanwhile, Italy is having a tough time finding buyers for its bonds. In order to sell debt, the yield is now above 7%, a line that (for some reason) in the popular press is read as the dividing line for “unsustainable”, kind of like the “Mendoza line” for baseball batting averages.

Italian bond yields rose above 7% on Friday (Dec 23) as worries about the government’s debt problems resurfaced. The yield on 10-year Italian government bonds edged up to 7.04%, after falling below 6% earlier this month. Italian yields first topped 7% in November amid fears that Italy could fall victim to the same debt crisis that led to bailouts for Greece, Ireland and Portugal.

On the face of it, this seems odd. Germany and the Netherlands are issuing bonds in Euros, just like the Greeks, Italians, Ireland and Portugal. Theoretically, all of these countries have the same “backstops” built into the Euro, and there is no exit mechanism.

The debt market is saying something different than what the politicians are saying – the debt market doesn’t believe the hype and, when the dust settles, they want to be holding paper from the creditworthy countries (Germany and the Netherlands) and not the PIIGS (the above countries plus Spain).

Back when Dan and I were in college we had a friend nicknamed “Strohs”. Since we were all very poor back then when we played poker often people used “markers” instead of cash. At the end of the game (generally when we ran out of beer and / or someone passed out) you might hold cash or you might hold “markers” which were really IOU’s from each person at the game. “Strohs” markers were a deck of cards marked with the ubiquitous “Dogs playing poker” picture, and thus at the end of the game if you held his marker, they were “Dogs”. “Strohs”, while a good friend of ours, wasn’t an especially credit-worthy guy (at the time). He earned his nickname by showing up for college with some clothes in a hefty trash bag and a pallet of Strohs 30 packs with which he filled his entire closet top to bottom.

So as the night wore on, if you held “Dogs” in your pile of chips and markers, your betting became especially reckless. It was common to say “I’ll raise you a bucket of dogs” which probably meant you were bluffing because if you lost all you did was remove the markers with which payment was unlikely to happen out of your stack of chips, for the promise of winning “real” markers (equivalent to the German debt above) or actual cash, instead.

For years books and magazines have focused on “yield” and also the credit worthiness of individual companies and (mostly) ignored currency risk. A friend of mine in the investment business talked about a customer who bought a huge Australian debt position and their piddly yield was irrelevant as currency gains from the Australian dollar (which I wrote about here) drove the position to a huge gain, when translated back into (weak) US dollars. Obviously this trader was ignoring yield and betting on currencies.

This is what appears to be happening today. When Europe’s dust cloud settles, people don’t want to be holding “a bucket of dogs” backed by promises from PIIGS governments’, they want the equivalent of the old Deutschmark from Germany. That is why they are essentially ignoring yield and accepting a negative yield from one country and demanding a 7% yield from another country ostensibly backed from the same currency.

Cross posted at LITGM

12 thoughts on “The Euro is Already Gone”

  1. Great points.

    Perhaps the Euro was never there, since the concept of having different interest rates under the same currency, as is necessary to prevent arbitrage of, say, Greek and German debt, is a sort of financial Escher drawing. The question was always how long can the system be sustained before its inherent contradictions overwhelm all other considerations.

  2. If the Euro is in so much trouble why is it worth so much more than our poor dollar?

    More than a few Germans wish that the wall was still up and they still had marks, I am sure.

  3. To me the Euro is a relic to how stunningly euphoric the western world’s policy makers were after the disintegration of the Soviet Union and collapse of the Berlin wall. I suspect there are many Europeans who are wondering what was the supposed value of this Euro anyways?

    Those poor French, they knew Maastricht was dubious. This may explain why the French voter only approved it by a 51% vote. The Dutch originally rejected it. The French were probably wondering what exactly they have to gain by allowing the Greeks, and others, use of the implied guarantee that the French balance sheet provided them.

    As my home California debates the value of a multi-billion dollar bullet train from Fresno to Bakersfield, I ask myself how long Texans, South Carolinians and others wonder what they have to gain, by allowing us to use the implied guarantee that their balance sheet, fiscal prudence and tax revenue provides. I cannot fathom DC allowing a state, particularly “The Golden State”, to default. I suspect there are many bond investors who feel the same. This mindset allows us to rollover debt to higher and higher levels.

    The ECB may not want to print their way to greatness but our Fed has no problem doing so.

  4. The Euro was a great convenience for any tourist and presumably for business. I think it was made clear too that ECB was forbidden to bail out European sovereign debt, but when has Euro Nomenklatura ever followed its own rules? There was no legal need to bail out Greece,but it wouldn’t do to have someone leave the Euro. This wasn’t really an economic project anyway ,but a dishonest political project. An incontinent political class has bought ruin to its subjects and possibly to itself,though it always is interesting to see how they get others to pick up the bill. I think the real source of enthusiasm for the EU rests in that it is such a rich provider of sinecures for clapped out politicians who could never hold real jobs, anyway. By the way,the salaries and pensions are tax free.

  5. Renminbi – I would not alter a word of your excellent,incisive post. I would only add that I was living in France when the euro came in and the French HATED it, and so, I believe, did the Germans. One is given to believe there are shoe boxes and old trunks full of DMs and FFs in the attics of France and Germany. They knew it was an absurd construct, imposed on a false prospectus, that would end in tears.

  6. Renminbi also suggests: “I think the real source of enthusiasm for the EU rests in that it is such a rich provider of sinecures for clapped out politicians who could never hold real jobs, anyway. By the way,the salaries and pensions are tax free.”

    Correct. Also, once they get their tootsies under the top table in Brussels, the emoluments are staggering. (The EU has been unable to find an accounting firm to sign off on their accounts for a mind-boggling 15 years.) And government is by appointment, not election. The Foreign Minister (although why the EU would need a foreign minister given that all the member countries have their own foreign ministers, and the EU is not a country) is an appointed nonentity from Britain. She has no job. One wonders how she spend her days. (A visit to the beauty parlour and the dentist wouldn’t do any harm.) Functionary after functionary, duplicating positions already held in real countries.

    British PM David Cameron, who has only ever held one job in his life … pr man for a failing TV company that went ahead and failed despite his lordly presence, already sees himself ensconced in the First Class dining car on the Brussels Express. The Deputy PM (invented because Cameron lost the election and asked the leader of the wanker Liberal Democrat party to throw his votes over) already receives a very robust emolument from Brussels under another arrangement.

  7. The EU was the culmination of a dream the Europeans have had almost since the end of WW2. I can remember stationed in Germany in the early 70s seeing the “EU” flag – blue with a circle of stars.

    But unless all the countries involved have the same fiscal policies having a common currency is trouble.

    Guess that last statement isn’t so prophetic these days ;-)

  8. “The EU was the culmination of a dream the Europeans have had almost since the end of WW2.”

    With respect, Eddie, that is not correct. No one dreamed of giving up the sovereignty that had been hard fought for, at great sacrifice of life, by the British, the British Commonwealth and the United States and the Europeans themselves, against the Germans. Frankly, the French don’t like the EU and, God willing, will prove it by electing Marine Le Pen. In Holland, Geert Wilders’ party came from nowhere to the No 2 spot in the country. The ones who want the EU are the non-achievers who are eager to share the wealth of the achievers, and Germany.

    There is absolutely no sane rationale for a melding of countries that have been, save Greece and a couple of others, well capable of running themselves for over a thousand years.

  9. Tyouth – I don’t understand your point. Are you saying France hasn’t been an independent country for well over a thousand years? England, an independent country, was invaded, and conquered, by the French in 1066. Then things settled down again.

    Italy got invaded a lot, but Norway, Sweden and Denmark have been independent countries always. And the only time England was invaded and conquered, was 1066. Even then, that was England, not what we know as Britain. England tried to conquer Scotland, but failed. I don’t recall Holland having been invaded. Parts of Spain were conquered by the muslims …

    I am seriously baffled by your post.

  10. Verity – Perhaps I should have amended it by saying “a culmination of a dream the politicians have had since WW2” Certainly a sizable number of the population wanted it; it wasn’t created in a vacuum.

    The idea certainly floated around since WW2.

    How do you think it came into being?

    I would agree that at least among the Germans and the French its popularity among the people has been mixed. The Germans rightfully resent having to bail out countries with foolish fiscal policies.

    It’s pretty much the northern countries having to bail out the southern countries.

    In Holland, Geert Wilders’ party came from nowhere to the No 2 spot in the country. The ones who want the EU are the non-achievers who are eager to share….

    If this is the same guy I am thinking of (Wilders) he seriously is on the edge of a “right wing nut” category – fueled by Dutch resentment of Muslim intrusion . As far as countries running themselves, Italy and Germany both came into being around 1870 if I am not mistaken? Germany was united by Bismarck and I believe both were comprised of small duchies before becoming a country.

    During WW2 there was serious talk in the Roosevelt administration of keeping Germany an agrarian country – and permanently divided into zones of occupation.


  11. Actually, Bill Brandt, it was created in a vacuum. None of the citizens of the countries involved was asked for their opinion or permission.

    The French people I know resent it fiercely and feel they were dragooned into it. As do the N Europeans, except Norway, which folded its arms and said “Nay” to the whole EU construct. Geert Wilders is a Dutch patriot who doesn’t want to see his ancient country subsumed by the Germans (who never give up) and, given his popularity – from zero to hero – the Dutch agree with him. His party came from nowhere to place second. Your description of him as a “right wing nut” tells me you have never seen him interviewed. And the British, under hideously weak leadership, spend a lot of time placating the French and Germans.

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