Doing my morning read of European disaster, it’s worth emphasizing the extent to which some of the large yield spreads in Europe are being driven by ultra-low rates in Germany rather than high rates elsewhere. In other words, we’re used to looking at the spread between what investors demand for Country X’s bond and what they demand for Germany as a key indicator of stress. A higher spread means bigger doubts about Country X. The logic is clear, and in the case of say Greece — giant spread driven by sky-high Greek interest rates — the implication is also clear. Greece is a bad credit risk.
But consider a statement like “Italian 10-year yields, which have recently taken up the mantle of prime eurozone stress gauge, and which at one point hit 5.75 per cent, are trading at 5.67 per cent up 10 basis points on the day.” U.S. 10-year Treasury yields were usually higher than that throughout the 1980s and 1990s. That’s not because the United States in 1997 was a bad default risk, it was just a pretty banal market price for a security in which investors had lots of other options. Our yields ended up consistently below five percent only after the dot-com bubble burst, and were a product of the ensuing recession and Chinese currency policy. Now of course Italy’s bonds aren’t trading in the high 5 percent range because of a strong growth outlook. They really are that high as a risk premium over Germany. But the point about that is that to have large spreads when Italian yields aren’t even especially high, German interest rates would have to be freakishly low.
And, indeed, this is the case:
What you’re seeing here, I think, is not just a reflection of market sentiment that German debt is safer than Italian debt, but also deep pessimism about the growth outlook in even the “healthy” European countries. That’s not to say that the United States is doing much better on this score, but it is a bit of real talk for people who’ve gotten smug about Germany amidst the problems of Italy and Spain. The fact of the matter is that an unworkable currency union plus unworkable austerity policies are not serving any country’s concrete economic interests very well.