10th January 2012

Just like a shower on a hot summer's day the Merkozy summit of yesterday seems already to have dis appeared without trace. However today I wish to point something out which illustrates the depth of the problem and the scale of the crisis. Regular readers will be aware that I use different interest-rates as signals as to what is happening and what will happen. Here is today's installment.

Greece has a one-year government bond yield of 372% and Germany has a one-year government bond yield of minus 0.03%. So there is a differential of just over 372%! As they are in a currency union if you felt that there was no risk of default everybody would sell their highly priced German bonds and buy Greek ones. Accordingly there we have a measure of the default risk which is 368%.

For those looking for a sense of perspective it was as recently as September 12th 2010 that I wrote about Greek one-year bond yields exceeding 100%.

If we move onto two-year bond yields the Greek version has blasted higher this week and is now at 175%. The German two-year Schatz is at 0.14%. So we have a differential of just under 175% per year here.

If we were examining an online economics textbook on currency unions it would probably start behaving like HAL in the film 2001 at this point! The situation above cannot be sustained for any length of time. You could consider the numbers above as part of the failure to add fiscal and political union to the currency union.

What changed in Greece?

It was interesting that it was the two-year bond yield in Greece which shot up yesterday (and accordingly the price fell heavily). It showed a change in the perceived default risk I think. As to the rationale then it was due to the troubles with the debt haircut plan (called private sector involvement or psi). As I pointed out yesterday there are two clear flaws.

"Apparently those who did not sign up to a 21% haircut and and 50% will be keener on a 55/60% one….."

"There is a deeper flaw in all this and that is as it stands a 100% haircut on the current basis would not bring genuine benefits to Greece."

Read more…


More from Mindful Money:

Euro breakup – Have you planned ahead?

Hungary: The newest problem for the eurozone

Are Eurozone banks 'hoarding' liquidity?

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