“Do like Germany (i.e. be a net exporter)” is not a valid economic recommendation, for the same reason that “do like Switzerland (be a tax haven),” “do like Singapore (be a city state with a major transshipment port),” “do like Egypt (control the Suez Canal)” or “do like Botswana (find diamonds)” are not.

- Jake

I’d say Germany lacks the imagination to make the Greeks more German in practice. I can’t find a way to say the rest without touching on WWII and I don’t want to go there.

Part of the brilliance of Augustus was the integration of various peoples into Roman ways. This was done peacefully. Even in Italy, most of the non-Roman population was distinctly non-Roman during the Republic. While Rome of course conquered, they learned to make people Roman, from Spain across N. Africa to the east.

Perhaps Augustus would have sent in the legions for some gunboat diplomacy. But then, the Roman emperors never were known for their grasp of the concept of imperial overstretch.

- Jake

I’m not sure what happens. We do seem to be approaching the point where the main creditor nations are going to have to make a decision about which loss they’ll take.

As an aside, can you imagine what an Augustus would do with this kind of leverage? He’d take a much greater degree of effective control over function. I mention Augustus because he was not merely power mad but was trying to spread the Roman way to the barbarians. He’d see this as an opportunity to make change happen.

What should be done is repeal Art. 123 of the Lisbon Treaty (first introduced in the Maastrict Treaty), to permit the ECB to function as a proper central bank.

But absent that, the internal deficit countries could start a bank, capitalise it with newly issued sovereign bonds, have that bank buy bonds in the primary market (at whatever interest rate it wants – it does not matter, as it is simply a pass-through accounting fiction) and have the ECB either rediscount the bonds or buy them from the bank (which is permitted by section 2 of Art. 123, since apparently passing through the bid-ask spread of a private bank turns a Eurozone bond from a debt certificate into a monetary instrument).

- Jake

Another possible interpretation of the rising bond prices and rising CDS spreads is that the bondholders are holding their bonds in their investment portfolios rather than their trading portfolios. Since the bonds still trade substantially below their hold-to-maturity value in the no-default scenario, bondholders may want to buy credit default swaps instead of realising accounting losses from selling the bonds in the secondary market. Given that CDS contracts are, as I understand it, typically structured with a series of small payments (as opposed to the instant capital loss from selling below the book value), this option would be particularly attractive for thinly capitalised institutions.

In other words, you may be looking at a case of quote-unquote “regulatory arbitrage.”

Or it might be about diversifying the *political* risk. Somebody over at European Tribune dug out some numbers that implied that American banks were selling most of these CDS contracts. By buying CDS contracts from American institutions, the European bondholders open the option of going to Uncle Sam for a bailout (by proxy, through the threat of wrecking what’s left of the US financial sector) if Merkel fails to bail them out through the acronym agencies (or, for that matter, a more direct handout).

My overarching point being that given the present state of regulation of credit default swaps, and the political power of the remaining private holders of deficit €-zone sovereigns’ bonds, the CDS spreads actually say very little about anything more interesting than the odds at Churchill Downs.

- Jake

And it should. Targetting rates is absolutely the right policy. Italy and Spain will have no problem servicing their debts at low interest rates. Full stop.

It’s not in northern europe’s interest to hang Italy and Spain out to dry like they have done with Greece, Portugal and Ireland.

I don’t see how ECB buying bonds is ever unsustainable – the ECB can create money.

Agree entirely on the CA issue – I’ve suggested before the Eurozone needs some regional form of Keynes’ proposed International Clearing Union which means adjustment comes on both sides.

This matters.”

Not necessarily. What’s the volume, and are these casino side bets or genuine hedges? Those distinctions matter, and we do not know them because credit default swaps are poorly regulated.

“Given recent questioning of France’s AAA rating If it continues buying without success couldn’t we end up with Germany backstopping the whole of the rest of Europe.”

Germany, Finland, the Netherlands. In other words, the members with internal current accounts surpluses. The underlying problem is that the internal current accounts imbalances are unsustainably large. There is no medium-term solution, let alone a long-term one, unless these imbalances are addressed on both the surplus and the deficit side.

The inclusion of internal deficit countries in these three- and four-letter agencies has always been political theatre to conceal the fact from the internal surplus countries’ voters. They have been treated to twenty years of Austerity, so anybody who comes right out and tells them that the mercantilist CA surpluses this Austerity secured will have to be surrendered will become politically radioactive. Hence the desperation among the surplus countries’ Very Serious People to make the deficit countries shoulder the full burden of maintaining the exchange rate peg.

Just a pity that a currency union that relies on the internal deficit countries to defend its exchange rate regime is inherently unstable.

- Jake