The Leaner (and Meaner) Eurozone

Either backtracking from yesterday’s “leaks” and/or denying rumors (whichever might be true) that Germany’s Chancellor Angela Merkel was actively considering the possibility of reconstituting the Eurozone, it seems to me that it is a foregone conclusion.   Hmmm, that is the nature of the beast, and the math, as it happens.

This article is a little bit dated at the moment, but it happens to be playing out exactly as predicted by author Yanis Varoufakis, an economist who heads the Department of Economic Policy at the University of Athens.  In this rather ingenious chart, Prof. Varoufakis demonstrates the manner in which destructive critical mass is now being achieved in the Eurozone.

What is particularly notable in this chart is the straight-up and simple math associated with economic and associated political necropathy.   In this case, rising debt levels lead to rising bond yield spreads lead to rising bailout requirements imposed on a reduced number of non-failing states. 

Simple enough, even if this view ignores the accelerant provided by failing bond holders (largely banking institutions) and those facing considerable derivative counter-party risk exposure.  These – and other – factors will, of course, ultimately control the rate (or slope) of the cascading failure pattern.

Also, you may note that even before each member state’s “point of failure” may be reached, in Prof. Varoufakis’ opinion, the rising tide of the Eurozone’s average yield spread (average yield compared to the lowest – i.e. the German Bund rate) acts, in effect, as a virus that weakens even the remaining healthy core.  As noted above, I’d certainly be inclined to add banking sector bailout to the “viral” burden. 

Be that as it may, Prof. Varoufaki’s has predicted that “critical mass” is achieved when the average bond yield spread reaches 7%.  By my own, quick & dirty (and unweighted) calculation, the current average spread is in the neighborhood of 5.3%.  The leading contributors:  Greece (30.67%), Portugal (9.88%), Ireland (6.49%), and now Italy (presently at 5.2% – with a bullet), followed closely by Spain (4.1%).

So, what we see with these supposed “rumors” of a new two-tiered EU would, in this context, amount to nothing more than economic triage.  There is a point in the contagion process where necrotic limbs must be (and will be) amputated.  It may also be noted that there is already a two-tiered EU in place.  Of the 27 EU member states, only 17 are in the Eurozone, sharing the Euro as common currency. 

The likeliest outcome, of course, is that this number (17) will shrink, even if the 27 doesn’t.  While it remains to be seen just how many will fail before this happens, it is worth noting that, at present, five of the Eurozone’s members have debt-to-gdp ratios above (the assumed critical level of) 90%.  These include (highest to lowest, as of 2010, mind you):   Greece, Italy, Belgium, Ireland, and Portugal.  Followed by Germany at 83%, which may well factor in just how quickly more extreme triage efforts may be required.  

Without question:  “Eurozone failure could be vast geopolitical shock.”  The US, of course, is facing similarly dire contagion risks and, while it may briefly continue to benefit from these EU troubles, that provides no cure for it’s own ills.


PS:  I’ve been informed that my taking notice of this critical 7% bond spread threshold is a little behind the curve.  Oh well, maybe a few others hadn’t yet picked up on it.  We’ll try to keep an eye on this situation.


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