Weeping Over Europe

Posted: Jun 19, 2012 12:01 AM

Spanish and Italian interest rates are rising, so what?  That’s the question I’m frequently being asked by listeners, readers, clients, and even advisors. 

Most understand that as interest rates rise, bond prices go lower.  And vice versa, as interest rates go lower, bond prices go higher. 

There seems to be a correlation between the rise in European sovereign yields (Germany and Switzerland) and the decline in U.S. Treasury yields. 

For those smart enough, and there weren’t many, who have positioned a sizable portion of their investment portfolio in Treasury paper, everything is working out quite well.  However, for every winner there’s usually a loser, and in this instance those currently suffering defeat are the people of Spain, Greece, Italy and any other country being forced to embrace austerity. 

The vicious cycle is easy to follow. 

The citizenry is told that layoffs are coming, pensions will be cutback, and paychecks reduced.  Yet, all the while, as these same citizens watch the day-to-day services being diminished, the costs keep escalating. 

The leaders (bankers & politicians) emphatically declare that if the general public will simply embrace austerity, the 5% yield on the debt will be able to be paid. 

Grudgingly, most people follow along, that is until the financial markets take hold and questions arise regarding whether or not the sovereign debt can actually be paid off, let alone have its interest paid. 

After that, in order to move forward, new debt must be issued.  Next, the presence of this new debt along with the existing rollover debt combined with worldwide uncertainty causes rates to once again escalate, approaching 6% then 7%, and subsequently even higher levels. 

Thus, unfortunately, all the so-called savings created by the austerity program is wiped away in a few, brief, trading sessions. 

Finally, the politicians and bankers make another appeal to the populace, telling them to do their duty and embrace austerity all over again. 

This brutal sequence of events repeats itself until the general public loses their patience.  Greece is getting closer to that point, but it seems the rest of the world is still embracing the vicious cycle. 

Will it take an election to break this cycle, or perhaps a black swan event?  The mainstream U.S. media still paints the Europeans as lazy and on the dole. 

But when you ask these same citizens to cut the fat and the muscle, and they agree, that’s one thing. 

To then ask them to cut the bone, a sure death, is something completely different altogether.  At that point, any person, anywhere, would rise up and categorically say no more.  As a Treasury bondholder, it makes me smile.  As a citizen of the world, it makes me weep.