Saturday, July 23, 2011

The Seven Percent Solution

I was somewhat astonished recently to see coverage of Goldman Sachs analysis that Italy could be in trouble if its ten year bond yield reaches 7%.  After all, the ECB has consistently brought out the sniper rifle and uncapped the scope when eurozone country's 10 year bond yield reaches 7% and puts the finger on the trigger when it exceeds 7.5% as it did with Greece, Ireland, and Portugal.  That is the point the ECB decides it is not going to continue providing liquidity and risk raising the eurozone average ten year interest rate.  It is also a level at which public debt in a fixed monetary union, in which trade imbalances cannot be economically resolved between countries and devaluation is only possible through internal adjustments which can only be achieved by austerity and deflation, verge towards unsustainability.  Deflation does not promote growth since growth creates inflation.  Consequently, the 7% level and the 7.5% trigger is the point of uncompetitive divergence at which imperial Europe dictates to colonial Europe that the Irish will become indentured servants to protect European banks, the Portuguese will be groomed to become serfs (after all the Portuguese social programs to bring the Portuguese people from dictatorship to the modern developed world cost money), and the Greek people will be pushed into slavery.

Understand the trading yields of the ten year bonds are not the concern except as they indicate what the issuing yield of any new ten year bonds might be.  Since Italy's economic growth is slowing, as Rebecca Wilder has thoroughly explained and Edward Hugh has documented, and Greece, Ireland, Spain, Italy, and France all have declining growth.  In fact, all of Europe is slowing in growth including German production amid global slowdown.  If these countries have a need to grow, whether inhibited by austerity or not, then they have a need to issue debt in the international market.  These countries also have high private debt which is a larger negative than public debt to GDP (at least less important in a fiat currency country).  If the newly issued debt is likely to be 7.0% - 7.5% or higher, depending on the size of the national economy and debt, the ECB will have its finger on the trigger.  The question of Spain, Italy, and France being to big, i.e., too costly to Germany and the banks of Europe, is a question which has been repeatedly kicked down the road just as recently as last Thursday and Friday and has already been viewed as a restricted default.

Are there any exceptions to the 7% solution?  Portugal tried to evade the ECB sniper by arranging private placements of public debt issuance but got too close to needing a true international auction.  The Cyprus ten year bond is trading in a volatile range, having exceeded 7.5% on June 23rd when Commerzbank recommended they no longer be bought, from 8.2% on June 29 to 8.9% on July 20 just before the newest kick the can down the road plan for Greece, which has temporarily lowered traded bond yields for all eurozone countries.  Why has Cyprus not had the trigger pulled?  It has not issued new debt in the international market since the ten year bond in February 2010 which was issued at 4.625% and is now trading at 8.9% as of July 20.  Cyprus has considered, and is considering issuing new debt in November at international auction, but has so far, as recently as this June, successfully placed the debt locally.  As long as it can stay away from the international market in issuing and placing debt, it will evade the ECB sniper.  With banks in Cyprus heavily exposed to Greek debt (Marfin alone has as much exposure as Dexia), new austerity budget which will decrease growth, and the need to rebuild the recently explosion damaged utility plant, the ability to place new debt locally and/or by private arrangement may become increasingly difficult.

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