Eurozone governments (which really means Germany and, perhaps, France) seem oddly unable or unwilling to make any real efforts to resolve the crisis in the Eurozone bond markets.
Firstly, it may be worth addressing exactly what a bond is as they are hardly part of everyone’s day to day life and the markets are not tracked every night on the news as the share markets are. A bond is a loan. You lend a party, in this case, say, Portugal, a sum of money for a specified period of time in return for regular interest payments. Like any loan, how much interest you charge will depend partly on how much you trust the other party to pay the interest to you and the principal back to you at the end of the term. The riskier the loan, the higher the interest you will require.
The problem in the Eurozone is that those who lend (who constitute the bond market) are concerned that some of the borrower countries may not be able to afford to repay their debts. As a consequence, borrowing for those countries is becoming more expensive and hard to find. Now, these countries have, in effect, a series of interest only loans to when they fall due, they have to find all of the money to repay them or another borrower to lend them more.
Since the start of the Euro, borrowing has been cheap and plentiful for member countries as the markets viewed them as having a similar level of probity to Germany, everyone’s favourite, so governments (e.g. Greece) have been borrowing like no tomorrow. Other countries didn’t borrow too much but their banks did and they have had to borrow to bail them out.
Now, sovereign states have borrowed more than they can afford since time immemorial and regularly defaulted. There are two main ways in which they have defaulted in the past; soft and hard. A soft default could be brought about because they allow the currency to devalue, meaning that overseas investors lose out, or they allow high inflation, meaning everyone loses out. In a hard default, the borrower would just refuse to pay interest or principle when it falls due, causing the lenders to lose money.
For countries which borrow in their own currency, the soft default will be more likely and continues to happen all the time, just imagine you had converted Swiss Francs to lend in dollars. Within limits, this does not seem to cause panic in the markets.
If, however, the country has not lent in its own currency (many emerging economies have to borrow in dollars), it could find that its payments become impossible to afford, even if it prints ever greater amounts of its own currency. In this case, it may just have to default as happened in South America in recent history, causing investors to lose their cash.
If the country no longer needs to borrow, this may not matter but it is rarely the case. Countries with debt problems almost always need to continue to borrow more and when markets close to them, they have to call in the IMF or another supra-national body to tide them over, often at the expense of promising to change their ways.
So, back to the Eurozone. They cannot engineer a soft default as the individual countries do not control their own currency or monetary policy (interest rates and inflation). They are also bound by treaty not to default. Also, Eurozone bonds were considered to be extremely low risk investments so Eurozone banks hold loads of them to support their capital requirements. If Greece defaults, it just creates a banking crisis in Germany, for example.
One option would be for some countries to leave the Euro but that could cause more problems than it solves, money in Greece would hardly stick around to be devalued, would it?
Another solution, and the one being pursued, is to restructure these economies to prevent them having to borrow more so that they can pay back their debt to more reasonable levels. That means that the population of the country suffer hardship to ensure that bond holders do not. The government tears up its promises to the electorate in order to keep those made to (often) foreign investors. Not a message guaranteed to generate votes.
Given that many of the problem Eurozone members are much less productive than the Germans, they will also have to endure a reduction in real wages (not easy with low inflation) to re-establish their competitiveness.
If the Eurozone politicians do not wrest control back from the markets with a bit of creative thinking, they could find that a long hot summer in southern Europe leads to mob rule and enforced change from below.
