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The Pain in Spain: Bond Prices Fall Sharply

Written by Gary North on November 16, 2011

We have read about Greece. It is obviously gong to default on its loans. The Eurocrats are pouring hundreds of billions down a rat hole to provide the Greek government with money to pay interest on its huge debt. They will pour lots more.

Italy is heading in the same direction. Its bond prices are up. It has a new government. But a new face will not change the grim reality. The country’s government is going to default, too.

Now comes Spain. A default by Spain is a far greater threat than a default by Greece.

Interest rates rose to over 6% this week. Rates did not rose slowly. They spiked up. This indicates a widespread realization that Spain is in as deep a hole as Italy is. A default by Italy is a bigger threat than Spain, but both may happen. The dominoes of PIIGS looks like they will topple.

If Spain defaults, the banks that hold its bonds will suffer huge losses. This would threaten the survival of the eurozone currency agreement, the monetary union. The Eurocrats dread that thought. They worked too hard to create the eurozone. But the system will soon need money — lots of money — to save the Spanish bond market from outright default. So, they pressure the European Central Bank to inflate. So far, it has resisted. But if Italy and Spain threaten default because of high rates, the ECB will inflate. It will do what it must to save the euro. But, in saving the eurozone from break-up, the inflation will ruin the euro as a rival to the U.S. dollar.

Problem: rising price price inflation raises long-term interest rates. This pushes down bond prices. So, existing bond investors lose money.

Investors in the IOUs of PIIGS are doomed to suffer losses, one way or the other. It’s just a matter of time.

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