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EU Bond Spreads and Germany’s Angst

More than a decade ago Europe was focusing on the worrying signs coming from the bond markets. At the time, bond spreads were seen as a measure of financial and economic convergence among the countries wanting to join the European Monetary Union at its inception. Today, in the midst of a dramatic economic and financial crisis, increasing bond spreads reflect the risk of a break-up of the Eurozone, as many countries with high public debt levels are under pressure. For the time being, Germany seems unwilling to collaborate in easing the strain, preferring national solutions to EU solutions.

The latest forecasts by the EU Commission show that the eurozone deficit-to-GDP ratio is bound to to increase to 4.0% in 2008 and 4.4% in 2010, from 1.7% in 2008. The debt-to-GDP ratio could balloon to 72.7% this year and 75.8% next year, from 68.7% last year. The reason behind this trend is clear: economy-boosting measures worth billions of euros have been announced in many European countries, increasing debt and deficit levels. In these circumstances, talk of a possible default of the weakest countries in the Eurozone has surfaced. Greece, for example, sold five-year bonds at the end of January with a yield three percentage points higher than German Bunds. One possibility being discussed at the EU level is to sell EMU bonds, backed by the richer countries, in order to ease the strain on the Greek budget or any other European budget that might be in trouble. In recent weeks, the German Finance Minister Peer Steinbrück rejected the idea, noting that it would increase yields on German government paper by one percentage point and weigh on the German deficit by some three billion euros per year. It is unclear whether eurozone bonds could alleviate the tensions in financial markets and reduce the risk of seeing a member State defaulting. That said, once again Germany gives the impression of concentrating on its home turf. In the past few months, Chancelor Angela Merkel rejected all possible Europe-wide solutions: Berlin boycotted an EU economic stimulus plan, an EU bank emergency fund, an EU bad bank, a now also an EU bond. The reasoning is that Germans cannot and should not shoulder other countries' debt and that a European solution is too expensive and too cumbersome. I understand the argument, but my impression is that the German government believes it can sail through the current crisis on its own. I am afraid that Germany's belief that it can be self-sufficient is not only illusory. Unfortunately, at this point in time, it is also putting in danger the solidity of the European Union.