Why the panic over 7%?

Today, there has been an earthquake in Turkey, a protest in London by students, and Greece literally without leadership. What is currently, at 11pm this evening, the lead story on the BBC News website? A number. 7%.

Why is this number so important? As my post of yesterday discussed, when governments borrow money, they have to pay interest on the loans. Germany is currently paying less than 1% on average for its bonds. Italy by comparison is this evening being charged over 7%, and that rate is simply too expensive.

So why are the bond markets insisting on such a premium on Italian debt? One of the main reasons everyone speculated was that everyone had lost faith in the former Prime Minister, Berlusconi, in solving the crisis. However, he’s announced his intention not just to resign, but not even to re-run for the forseeable future. So there must be other things concerning our financial lords and masters.

Italy’s debt is huge. It’s currently borrowed 120% of GDP (or thereabouts). This is the equivalent of you or I buying 120% of our annual salary. That sort of loan takes either ages to pay off, or requires paying such a large chunk back each month you struggle to make ends meet. And that’s where Italy is right now.

There’s a further complication. To prevent such a crisis, the countries that are members of the single European currency formed the EFSF, the European Financial Stability Fund, to lend money to countries who got into difficulty. It’s already helped Ireland, for example, when it’s bonds got too expensive. At 7%.

The EFSF was given €440Bn to keep Europe safe. But most of this has already been spent on Ireland, Portugal, Greece and the banks. There isn’t enough funds to protect Italy . There would need to be at least €1,000,000,000,000 to protect Italy too, and some are saying double that. And no-one, not even the mighty China, has the funds that they’re willing to commit to Europe.

There is a solution. The European Central Bank could print extra money in the interim, and lend that to the EFSF, similar to the Quantative Easing that the Bank of England is currently doing. The problem here is the ECB is reluctant to take on that role, and even if it were, Germany is currently refusing permission for that. We can’t rush to blame the Germans; printing extra money makes they money we all hold worth less than it did before, while printing lots of new money makes it worthless. This happened to Germany before, in the 1930’s, when their economy reached hyperinflation, the currency collapsed, and in desperation the public voted for the Nazi party.

Thus inflation scares Germany, especially with the iron-tight control it has over its own finances. But also the mere notion of allowing one’s country to get out of financial control is a concept alien to the Germans. They simply can’t comprehend how the Italian and Greek governments have allowed their finances to get so out of hand that they’ve reached this point. The French and German taxpayers too are frustrated with their neighbours’ actions.

So any solution to this isn’t going to be swift. Either Germany needs to be persuaded to ignore the demons of its past and allow the ECB to print more money (and gamble inflation doesn’t become too much of an issue), or it needs to find a way to persuade the market that Italy isn’t a risk and to lower it’s own bond rates. With the EFSF and the Italians running out of money, and the world’s investors and financiers at the end of their tether, they could need a lot of convincing.




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