Friday, June 15, 2012

The Crisis Carried Off All the Spreads...

Here is a fascinating chart that I plucked from the bowels of the internet. It shows the bond yields of various Eurozone economies, plus the U.K. A few things to point out:

1. Look how the yields were already converging before the creation of the euro; the euro was something that was expected to lower interest rates for the periphery by allowing them to borrow "at German rates" but it looks to be like it was going to happen anyway, probably due to the free flow of capital that came with the Common Market.

2. Rates stayed low and converged from 2002-2008, when the financail crisis hit and Nominal GDP collapsed. This is a pie in the face to people who think the fiscal crisis is all about the periphery loading up on debt. If thats the case, YIELDS SHOULD HAVE DIVERGED AS DEBT WAS MOUNTING. Greece, Italy, and Portugal did not suddenly start running deficits in 2008. Spain and Ireland were running SURPLUSES.

3. To belive that credit markets happily loaded up on way to much periphery debt without thinking about it and keeping rates low and then suddenly decided debt was out of control and that rates needed to soar is to imply that financial markets are so irrational and unpredictible that bond trading should be outlawed. Today. Somehow, I doubt anyone actually intendeds to make that arguement.

4. Clearly, another explaination is needed. And that explaination is that the ECB has beening running a tight monetary policy since 2008, which is to say a low rate of growth of the money supply relative to the velocity of money, which together determine Nominal GDP. And this low growth has made debt levels unsustainable when they would otherwise not be.

PS: I realized Mark Thoma had the same chart on his blog earlier that day. Not where I got it from, though that place probably got it from there. Just so nobody thinks I consider one of my favorite blogs the "bowels of the internet."

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