To get an idea of how the global financial crisis is testing the stability of the eurozone, look at the ever-widening spread between the yields on German and Italian 10-year government bonds: 25.8 basis points one year ago, 69.6 one month ago, 72.3 one week ago and 95.6 today.
With Greece the situation is even more acute: the spread between German and Greek bonds shot above 100 basis points last week for the first time since Greece adopted the euro in 2001. It is now close to 120 basis points. Portuguese, Spanish, Belgian and even Austrian and Dutch yield spreads are also wider than at any time since Europe’s monetary union started in 1999.
A widening spread means that investors judge it riskier to buy the debt of, say, Greece and Italy than the debt of Germany. Accordingly, they demand a higher premium.
For sure, it would be an exaggeration to say that spreads on today’s scale imply serious doubts among investors about the ability of Greece and Italy to honour their debts. But they do imply that investors lack full confidence in Greek and Italian fiscal policies.
They also serve as a reminder about the uncomfortably high levels of Greek and Italian public debt. Finally, they hint at a degree of uncertainty among investors about the cohesion of the 15-nation eurozone itself – namely, whether Greece and Italy are economically strong and fiscally disciplined enough to share the same currency with Germany over the long term.
This would not be an issue, of course, if the eurozone were like the US and had a central fiscal authority to transfer revenues between flourishing states and states suffering an economic shock. But you cannot have a central fiscal authority without a much greater shift in the direction of European political union than most politicians, taxpayers and voters appear ready to contemplate.
Even appeals for closer co-ordination of macroeconomic policies among eurozone governments meet resistance. This was was seen last week in the response to President Nicolas Sarkozy’s call for new and stronger arrangements for joint policymaking in the euro area.
Sarkozy’s proposal had its flaws and, in any case, such appeals coming from France are always liable to be interpreted as an attempt to place the European Central Bank under political control. Nonetheless, Sarkozy put his finger on the problem.
The global financial crisis is beginning to test Europe’s ability to operate a multinational monetary union without closer political and institutional integration. Since 1999, Europe has had its cake and eaten it: the pleasure of a single currency that symbolises European unity, without the pain of a political union unpalatable to so many of its policymakers and citizens.
But as the bond yield spreads show, if the financial crisis gets any worse, Europe will find itself facing some extremely difficult choices.
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