European Debt Crisis – Next Country?

The European debt drama continues bouncing between a Greek and Shakespearean tragedy.

Pain has finally gotten the upper hand and provoked change in Italy.  Rising interest rates for bonds did what scandal and corruption revelations couldn’t; Prime Minister Silvio Berlusconi of Italy has been deposed.  He has been replaced by Mr. Mario Monti a former EU Commissioner and technocrat who has launched plans to convince the markets that Italy will mend its spendthrift habits and not default on its debts.

Greek and Spanish governments have been overturned by the debt crisis also.  Are bond rates the new revolutionary or anarchist that can overthrow governments?

Italy Makes a Move

On Dec. 4th Mr. Monti announced a three-year package of fiscal adjustments to shrink spending by $ 40 Billion.  These measures include real pain for Italians:

  • There will be a major drive to tackle tax evasion, including a ban on cash transactions in excess of 1,000 euros, down from a current limit of 2,500 euros.
  • Local housing tax reintroduced (3.5bn euros per year)
  • VAT rises
  • Property sales (5bn euros per year)
  • Utility sales
  • Health spending cuts (5bn euros from 2013)
  • Pension ages will rise to 62 for women and 66 for men, and most payments will be unlinked from inflation. The pension age for women will rise to 66 from 2018.

A day later, the Italy’s 10-year bond yield had fallen to about 5.95%, from 6.66% at Friday’s close.

Anticipation of more good news from later this week from European leaders has caused bond interest rates to drop for other European nations.  Only time will tell whether European leaders will deliver on their promises for a permanent fix to the European debt crisis and investors will agree by lowering the interest rates they demand for wayward countries.

Bond Rate Comparative (Dec 5, 2012)

A comparison of country bond yield rates and national debt provides a view of the future.  The countries with low interest rates today are not that far from the abyss.

Country Bond% Debt GDP %

Greece          32.5%        116%  (Bailout)

Portugal      12.8             93%  (Bailout)

Italy               5.8           118%

Spain              5.1           61%

Belgium        4.3           96%

France          3.3           82%

Netherlands 2.6           63%

U.K.               2.3           47%

Germany       2.2           63%

U.S.                2.1           60%

Sweden         1.8           40%

Investors are evidently apolitical and are voting for socialist Sweden!  It would be fun to have the Republican Presidential candidates explain why socialist Sweden is loved by investors.

Safe Haven – It is all Relative

As the table illustrates the US is not much different from other near crisis countries like Spain with 60% debt to GDP. And like Spain, our national debt is climbing rapidly caused by our slow economic growth, low tax income, high government spending and Congressional gridlock.

For the moment the US is a safe haven.  One investment analyst referred to the US as “cleanest dirty shirt”. Global investment funds started flowing to the US in the fall of 2011 seeking to avoid the higher risks in Europe and Japan.  Recently US banks and money funds were pulling their funds out of European banks to reduce their risk as well as European bonds. The fear of debt disaster in Europe is keeping our interest rates low.

  • When will investors start looking at the US and other countries that have high debt and increasing their interest rate demand?
  • What if Europe fails to act and drags itself into a recession, with nasty implications for our weak economic recovery?
  • When will investors get tired of Congressional gridlock as they have with European leader inaction and bandaids?

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