Europe – Renew your vows or file for a Divorce

At its time of establishment, the Economic and Monetary Union (EMU) was political driven and not economically driven. A number of economists predicted the EMU's current problems twenty years ago, if only we had listened then...

Earlier this week Italy paid 8 percent to sell three-year debt. To put things in perspective, an individual with a decent job can borrow money from a bank at superior rates than a core European country. The classical CAPM theory and the way we think of asset pricing might need to be re-vised when the "risk-free" rate of return is so risky.

Today was a big day for Europe. Spain and France announced and successfully sold €8.1 bn of new debt- Thankfully the auction was oversubscribed. French and Spanish Banks, as ever before, played an active role in today's bond auction.

France in particular, took a brave and rather silly gamble with the sale of bonds- having completed all funding requirements I consider this a “asymmetric kamikaze” move. The auction was expected and did sell out, mainly due to subscriptions from local banks. Anything less than such an outcome would have created total chaos. The idea that markets would find confidence with French banks buying domestic French bonds as they have done for the last decades is rather naïve. For confidence, investors are looking for something extraordinary. Some form of re-assurance. Not just confirmation that the same banks are buying the same bonds. Also, let us not forget that France ended paying 204 basis point above German bunds, indeed confirming that investors no longer categorize Germany and France in the same bucket. And if the French government are trying to secure funds while the cost of borrowing is high (relative to Germany ofcourse), it makes you worry what their own internal expectations of the future are. 

So the world turns their head and looks towards the ECB for a solution and again the ECB turn their head in the opposite direction and Mr Draghi confirms their “limited” role as lender of last resort. We are quickly reaching the point where liquidity concerns are real and core European countries are struggling. Until something extraordinary happens I expect that Europe will continue sliding deeper into this debt crisis. For this extraordinary somthing, I feel that the ECB needs to provide some form of liquidity in this drying up market.