In response to EU Calls Emergency Meeting on Italy; Don’t Worry “It’s a Coordination, Not a Crisis”; Short Sellers Blamed; Junckeritis Spreads I received an interesting comment from “fedwatcher”

The “Bond Vigilantes” are out in force in the European Sovereign Debt markets. What is at risk here is not Italy, rather it is the Euro itself.

The Euro-zone suffers from an incomplete financial system. The collection of sovereign states that adopted the Euro have toothless central banks that in turn depend on a toothless ECB. The ECB is not a central bank equivalent to the U.S. Federal Reserve or the Bank of England as there is no European Treasury and no central taxing authority. Rather the Euro-zone states depend on the support of individual banks and those banks are all over levered with too much sovereign debt.

The assumption was that these banks did not have to have reserves against sovereign debt as there was no default risk. As the real problem of default was recognized, these banks bought Credit Default Swap insurance but the “insurers” cannot pay off.

The PIIGS have the power to bring the Euro down. That is their hole card. The German public has the power to bring the Euro down. That is Berlin’s hole card. The French have no hole card and across the border in Belgium you have a sovereign state largely dependent on its hosting of many EU bureaucrats.

Many European banks are on life-support from the U.S. Federal Reserve since the EU is toothless. Thus, the U.S. is a hidden party to these negotiations.

So in the Euro-zone we have insolvent banks, insolvent governments, and a currency union that lacks the full set of tools to survive. No wonder the Bond Vigilantes are out in full force.

Portugal 2-Year Government Debt Yield

Portugal 10-Year Government Debt Yield

Italy 2-Year Government Debt Yield

Italy 10-Year Government Debt Yield

Spain 2-Year Government Debt Yield

Spain 10-Year Government Debt Yield

Ireland 2-Year Government Debt Yield

Ireland 10-Year Government Debt Yield

Greece 2-Year Government Debt Yield

Greece 10-Year Government Debt Yield

Germany 2-Year Government Debt Yield

Germany 10-Year Government Debt Yield

For further analysis, please see Invisible Elephant Now Visible; EU Ready to Tell Trichet to “Stuff It”; Help for Italy?

Mike “Mish” Shedlock
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