Be scared when investors throw money at Germany

Euro sign Image copyright Reuters

What some may see as alarming about today's significant rises in the interest rate that Italy, Spain, Belgium and France would all have to pay to borrow is there hasn't been any particularly bad news - but even so, investors remain wary about lending to eurozone governments with relatively high debts and a requirement to borrow substantial sums in the coming year.

The new prime minister of Italy, Mario Monti, seems on course to form a government of supposedly technocratic talent.

And although new figures show that the Dutch economy contracted in the three months to the end of September, the bigger French and German economies were still growing - and the eurozone economy as a whole is estimated to have done marginally better than flatline.

However, investors and markets look forward not back. And a series of statistics indicate that the eurozone is heading for an economic contraction, which would make it even harder for the financially weaker governments to repay what they owe.

Against that backdrop there were three worrying developments today.

Spain was unable to borrow the maximum 3.5bn euros it wished to do - and investors ended up demanding the Spanish government pay an expensive 5% interest rate for supposedly risk-free 12-month loans (Belgium too didn't sell the maximum debt on offer).

The implicit interest rate on 10-year loans to Italy (the yield on 10-year bonds) rose again above the 7% level which is regarded as punitively unaffordable.

But perhaps most important - and worrying - is that the gap between what France would pay to borrow and what Germany pays to borrow widened to a record.

That suggests France is perilously perched on the cusp between being part of the solution to the eurozone's financial woes and becoming an intractable part of the problem: neurotic investors fear that the French government's balance sheet and French banks may not be strong enough to underwrite the size of bailouts that could turn out to be necessary for Italy and Spain.

As ever, a drop in the yield on German bonds, the fall in the implicit interest rate it would have to pay, is not a sign that investors are any more hopeful that a solution to the eurozone's stresses are anywhere in sight.

The reverse is true.

When you see investors wishing to hold more German debt, it means they are becoming more pessimistic about the ability of other eurozone governments to repay what they owe.


When you lend to Germany, you are making an each-way bet: either the eurozone will break up, in which case you might get back soaraway Deutschmarks in place of the euros you've lent, or Germany will eventually decide to bail out the whole of the eurozone, and the value of the salvaged euro would rise in general.

Well that's the theory.

In practice, the outcome might be a rescue that was too little too late, such that the eurozone became a growth-free zone punctuated by debt crises for years. If that were to happen, even lending to Germany might turn into a sucker bet.

That fear may already be nagging away at the back of investors' minds. Because today we saw them piling into German debt, while eschewing the debt of other AAA governments, Austria and the Netherlands.

If Germany is now seen as the only safe haven in the eurozone, even its days as a safe port for any storm may be numbered.