Who Let The PIIGS Out?

Do you remember a couple of years or so ago when Europe was such an economic basket case that serious discussions about the continued existence of the Euro as a viable currency was hotly debated?  Well, Europe is still a mess in my humble opinion, but more about that later.  What I find of particular interest at this moment is the apparent vigor within some of the more problematic members of that union.

The European economy started unraveling in a serious way on the heels of our own collapse, and it did so for reasons similar to our own indiscretions.  Like us, the housing markets had soared in price,  was massively overbuilt, credit standards were continually lowered, and bad loans were bundled into obscure vehicles which tended to hide their shaky foundations.  When all of this came to a head, first here, then abroad, the subsequent collapse brought banking to a standstill, unemployment soared, and wealth began to vanish in huge chunks.  Some nations there felt the pain more deeply and many pundits did not see how they could possibly survive as viable members of the European Union.  Specifically, Portugal, Ireland, Italy, Greece and Spain were listed as those most likely to fail.  They were often referred to as a group by the acronym PIIGS.

Interest rates are typically seen as a measure of risk.  The riskier a loan appears, the higher the rate of interest levied on the loan tends to be.  Thus, back then, the PIIGS were paying a hefty premium for their troubles with percentages in some of the weakest reaching into the teens for longer dated bonds; interest rates for shorter term  paper even rose above 30% in Greece!  In Spain, seen during this period as a problem but not one as egregious as Greece, had interest rates on 10-year loans stretch up to 6.5% and higher.

While conditions today have not changed all that dramatically, interest rates have fallen substantially.  For instance, in April Greece was able to borrow via 30-year bonds at a rate of 4.5% despite seeing internal unrest continue.  But the strangest tale comes from Spain where the 10-year rate there just fell a smidgen below our own at around 2.6%!  This is a country where some states are seriously proposing secession, the king just abdicated, housing is still a mess, and unemployment persists around 25%.

How is it that the erstwhile PIIGS can now borrow so cheaply when for many of them their economies continue to teeter on the edge of recession or downright depression?  Historians may someday spin it differently, but for now we will lay this phenomena squarely upon the European Central Bank where short term rates were just dropped below zero.  That’s right; you have to pay them to hold your deposit.  It appears that money will go wherever it must to realize some kind of yield no matter how paltry or how risky that may be.  Our conclusion?  The seeds of a subsequent collapse, quite possibly worse than the last, are being planted by the very forces intended to engineer stability.           (by J R)