The European Crisis Is Reaching A Tipping Point
BJ: The European sovereign debt crisis is rapidly approaching what could be a significant tipping point as it threatens to spread to the heart of Europe. In recent days Italian 10-year bond yields have soared to 7.22% and today Spain was forced to pay 6.975% at its auction. Even French 10-year yields have climbed to 3.71%, its widest spread over German bond yields since the Euro Zone was started. All of this has happened despite large ECB purchases of periphery country bonds over the last few months and the installation of technocratic governments in Greece and Italy.
The fear has now spread to the heart of Europe. Jennifer Mckeown, senior European economist at Capital Economics stated that, "Growing concerns about France threatens to take the Eurozone crisis to a new level. If a further rise in bond yields or large bank losses leave France unable to support the periphery, the burden on Germany and the few remaining 'core' might become too heavy to tolerate."
Although hopes were raised based on new technocratic prime ministers in Greece and Italy, any policy based on fiscal restraint and austerity will send their economies into further decline resulting in even higher deficits and bond yields. This could be accompanied by further defaults that send shockwaves through the global economy and financial system.
Despite the urgency, Europe's leaders still cannot decide upon the best course of action since all of the available options have potentially serious side effects on the economy and financial system at a time when Europe is already headed for a recession, if it is not already in one. EU industrial production for October was down 2% while Germany's ZEW (confidence index) has entered deep recessionary territory. The leading indicators for Italy and France have also dropped to levels indicating recessions in the past. Austerity unaccompanied by national monetary policy and the ability to devalue can only exacerbate this negative trend.
The problems appear to be spreading to the rest of the globe as well. Both Indian and Brazilian industrial production is weakening while their leading indexes are pointing down. Korean industrial production has been flat all year. Notably, the developing nations' economies are heavily export-driven, and Europe is an important customer for their goods, although there are undoubtedly country-specific factors at work as well.