When The New York Times has figured it out, it’s real. This story reports on what amounts to a run on the banks. Rich investors are selling PIIGS bonds, pulling out of PIIGS banks, and fleeing for safety.
This forces up interest rates in PIIGS countries. This forces banks to raise rates to borrowers. This creates a recession. This lowers revenues for the PIIGS governments. This raises PIIGS interest rates, as investors flee. It’s a downward spiral. Europe is now trapped.
The PIIGS are at the front end of this crisis, but northern Europe is not far behind. Northern Europe sells goods to residents of the PIIGS. Sales are stagnant. Soon, they will be falling.
This will tens to benefit the sale of bonds in northern Europe, but crash the stock markets. Investors will seek greater safety in bonds — just not PIIGS bonds. They will sell stocks.
This will put pressure on the European Central Bank to inflate. That’s what central banks do in a recession. This is Keynesian policy. The ECB has officially resisted inflating, but this cannot last much longer.
If this trend continues, it risks creating a vicious cycle of rising borrowing costs, deeper spending cuts and slowing growth, which is hard to get out of, especially as some European banks are having trouble meeting their financing needs.
“It’s a pretty terrible spiral,” said Peter R. Fisher, head of fixed income at the asset manager BlackRock and a former senior Treasury official in the George W. Bush administration.
The head of the ECB insists that the ECB will remain firm.
On Friday, the bank’s new president, Mario Draghi, put the onus on European leaders to deploy the long-awaited euro zone bailout fund to resolve the crisis, implicitly rejecting calls for the European Central Bank to step up and become the region’s “lender of last resort.”
I suggest that you do not believe him.
The following represents a modern bank run — not by small depositors, but by large fund lenders.
At the same time, American institutions are pulling back on loans to even the sturdiest banks in Europe. When a $300 million certificate of deposit held by Vanguard’s $114 billion Prime Money Market Fund from Rabobank in the Netherlands came due on Nov. 9, Vanguard decided to let the loan expire and move the money out of Europe. Rabobank enjoys a AAA-credit rating and is considered one of the strongest banks in the world.
The ECB is taking steps to relieve the crisis by inflating.
Traders said that fewer international buyers were stepping up at the auctions. The European Central Bank cannot buy directly from governments but is purchasing euro zone debt in the open market. Bond rates settled somewhat Friday, with Italian yields hovering at 6.6 percent and Spanish rates around 6.3 percent; each had been below 5 percent earlier this year.
The experts say “No problem.” That’s what they said in 2008.
Just as American policy makers assured the public then that the subprime problem could be contained, so European leaders thought until recently that the fiscal troubles of a small country like Greece would not spread.
But after the bankruptcy last month of MF Global, spurred by its exposure to $6.3 billion of European debt, other institutions have raced to purge their portfolios of similar investments.
“This is just a repeat of what we saw in 2008, when everyone wanted to see toxic assets off the banks’ balance sheets,” said Christian Stracke, the head of credit research for Pimco.
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