German bond auction “disaster”

Yesterday’s auction of 10 year Bunds has been described as a disaster, and led to sharp declines yesterday in Europe and the US and today and Asia.

While disaster is possibly overstating it, it’s certainly not good news, and hopefully is wake-up call the Germans need. Germany has been caught on the horns of a dilemma for the past few months. It is quite clear the only way to save the eurozone is for the ECB to step in and buy Government Bonds openly in the primary and secondary markets, so capping rising government interest costs and giving those governments a chance to get their financial houses in order and implement much needed austerity plans. The alternative is the expulsion of many current members of the Euro.

The Germans problems are both legal and ideological.

Legally no country can leave the Euro – there is no mechanism to allow for it.

Similarly the ECB cannot fund European governments. Of course the ECB is already playing fast and loose with this by buying on the secondary market, claiming that is somehow different to buying at new issue.

Ideologically Germany is opposed to monetisation of debt buy Central Bank buying. They are concerned with 1930s style hyperinflation. And well they might be to be concerned, seeing as that hyperinflation led to the rise of Hitler. But as I said yesterday, there is no chance of hyperinflation in the immediate term. Velocity of money has collapsed. Individuals, companies and banks are hoarding cash and not spending. That is why QE is hopeless as a stimulus tool, but it also why EB buying of Government debt makes sense. It takes the panicked market makers out of the equation and gives governments time.

Once confidence is restored the ECB can either simply sell the bonds or let them mature and be repaid by the relevant government, keeping the money out of the system and preventing an inflationary spiral.

Germany needs to finally face up to this reality.

It will still lead to at least a Europe-wide recession as austerity bites, and probably a nasty one, but the alternative is far worse.

It’s time for everyone to accept that there will be no recovery for many years. This is going to hurt.