I think of it as an “oops” moment: the US goes into a recession; Europeans believe this deserved punishment has little to do with them; the European economy slows unexpectedly; the US throws everything at restoring growth; finally, the US recovers, pulling Europe behind it.

Yet this is not just a slow-down. It is also a financial crisis. What if the solvency of a eurozone member came into doubt? After all, spreads over rates on German bunds and the prices of credit default swaps have risen already, the most affected countries being Belgium, Greece, Ireland, Italy, Portugal and Spain (see charts).

Eurozone members are like local governments. If they were unable to refinance their debt, they would be forced to default or need outside rescue. True, even the Greek spread of 165 basis points does not imply a high probability of default. The actual rate of interest – 4.7 per cent – is not unmanageable either. Yet markets can shift at great speed. It is possible to imagine a “sudden stop” on higher-risk sovereign bonds. That would force the debt to become short term – a classic route to a crisis.

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December 10, 2008 1:21am in Eurozone | Comment