Grumpy Old European

There’s an old joke about a dinner party being rudely interrupted by a masked gunman demanding the surrender of money and valuables. One chap surreptitiously hands his neighbour 50 euros, whispering “Here’s what I owed you.” In essence, this is what’s happening across Europe as the markets call in the debt.

exposure to Belgian sovereign debt
Not pocket change: exposure to Belgian debt

This graphic nicked from the FT (thanks, hope you don’t mind chaps) shows how €500bn of Belgian pubic and private sector debt is spread among the region’s banks. If you can, visit the interactive graphic, where you’ll see the pattern repeated across Europe (Belgium was chosen for aesthetic reasons). Now imagine all these banks and governments seated at the dinner table, squirming to find a way to leave with the least loss.

Alerted to the situation, Inspectors Rehn and Juncker arrive on the scene, followed by Detective Trichet. Unfortunately police chief Merkel hasn’t given the two inspectors a big enough weapon to seriously deter the gunman and the detective is keenly aware that he has to pay for his own ammunition and is therefore reluctant to do more than make the bulge in his jacket visible. The gunman is getting increasingly jittery in a tense standoff.

Suddenly Constable Barnier bursts into the room with a plan for ensuring taxpayers won’t have to foot the bill for bank failures in the future: the bondholders will take the hit. What a relief.

Except it isn’t. The memo accompanying today’s announcement declares that it “should not be read across to the current debate around sovereign debt.” But, rather like the way in which the announcement of the project for the European Stability Mechanism is said to have led to the Irish bailout, the markets appear to have done just that: the gunman is waving his gun around again and the FT headlines: “Euro slides as peripheral debt yields spike.

Why? The new Money Supply blog at the FT reasons thus:

Here they are talking about bank bondholders. But government bonds – already jittery – are feeling the pain. There seem two likely explanations for this. First, that markets believe bondholder rights will be viewed the same way by the EC, whether bank or sovereign. In other words, today’s news makes it more likely sovereign bondholders will also face losses in the event of default.

There is another, more alarming explanation. That is that all debt is now one. Governments often own lots of banks, after all. Are their holdings so great that the value of their own debt now depends upon that of their banks’?

If this seems arcane, bear in mind that government bond yields (in the secondary, resale market) are the best indication we have of how much governments will pay on debt they raise – confirmed by recent auctions. And governments – i.e. taxpayers – will pay ever more of their GDP servicing their debt.

One way or another, we’re all going to pay, and probably sooner as well as later. Unless, of course, you’ve got a very sneaky hiding place for the cash your neighbour just slipped you.

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