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Wednesday, 25 July 2012 00:00
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That's the crux of what Moody's is telling Germany

With German bond yields hitting multi-decade lows, so much so that investors are actually paying the government for holding on to their cash, the official reaction to Moody’s changing its outlook to negative from stable is hardly surprising. “By means of its solid economic and financial policy,” the finance ministry said in a written statement, “Germany will retain its ‘safe haven’ status and continue to play its role as the anchor in the eurozone responsibly”—a statement similar in tone to the US stance when S&P lowered its outlook. The question that Moody’s is asking, and the increased German CDS spread from 40 bps two years ago to well over 100 now suggests others are also asking the same thing, is how long Germany can remain unaffected by the euro crisis. Even if you assume, incorrectly, as the rapidly-spreading US subprime crisis showed, that a possible Greek exit from the eurozone won’t cause Germany a problem, what happens when Spain and Italy need a bailout? Spanish bond yields are already at an all-time high of 7.5% (till a few weeks ago, a 7% number was seen as being above the danger mark). With inflation at around 2%, that means the government is paying a real interest rate of 5.5% and, with a contracting GDP, that’s a recipe for a spiralling debt-to-GDP ratio. Reuters Breakingviews editor Hugo Dixon quotes Citibank as projecting Spain’s official debt-to-GDP jumping from 69% at the end of last year to 101% at the end of next year and Italy’s from 120% to 135%.

Juxtapose this with the fact that, with its 730 billion euro debt, Spain is just one notch above debt; and with a 1.9 trillion debt, Italy is just two notches higher—with their worsening debt profile, a rating change can be disastrous, and the consequences for Germany dire, the most obvious of which will relate to German bank holdings in these countries. It is surely frightening that all of this is happening after Greece has received a 150 billion euro bailout already, Ireland 50 billion, Portugal 55 billion and Spain has been promised 100 billion for its troubled banks. So while Angela Merkel can play to the gallery by telling MPs, “I don’t see total debt liability as long as I live,”—meaning EU members will not guarantee each other’s debt—and MPs may think she’s doing the right thing when they applaud her by saying, “We wish you a long life,” this does look short-sighted. Germany’s desire to see the ‘Club Med’ countries practice austerity is all very well but as McKinsey has pointed out, none of those associated with the eurozone crisis had excessive debt; FT’s Martin Wolf has shown they didn’t have high deficits either. The way the crisis is spinning out of control, immediate solutions like beefing up the bailout funds or Dixon’s 50 billion euro interest subvention scheme (http://goo.gl/7jbiX) are called for. Merkel would do well not to let the historically low bond yields fool her.


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