Way back in July Paul Krugman asked why Italian and Japanese bond yields were diverging despite similar debt and demographic issues. He didn’t have a firm answer (his words, not mine):
“A question (to which I don’t have the full answer): why are the interest rates on Italian and Japanese debt so different? As of right now, 10-year Japanese bonds are yielding 1.09%; 10-year Italian bonds 5.76%.
…I actually don’t have a firm view. But it seems to be an important puzzle to resolve.”
In today’s NY Times op-ed he appears to have resolved this great puzzle:
“What has happened, it turns out, is that by going on the euro, Spain and Italy in effect reduced themselves to the status of third-world countries that have to borrow in someone else’s currency, with all the loss of flexibility that implies. In particular, since euro-area countries can’t print money even in an emergency, they’re subject to funding disruptions in a way that nations that kept their own currencies aren’t — and the result is what you see right now. America, which borrows in dollars, doesn’t have that problem.
The other thing you need to know is that in the face of the current crisis, austerity has been a failure everywhere it has been tried: no country with significant debts has managed to slash its way back into the good graces of the financial markets. For example, Ireland is the good boy of Europe, having responded to its debt problems with savage austerity that has driven its unemployment rate to 14 percent. Yet the interest rate on Irish bonds is still above 8 percent — worse than Italy.”
This will all sound familiar to regular readers here. After all, I’ve been explaining for a long time that the Euro is inherently different because it’s comprised of countries that have reduced their monetary sovereignty by constructing a monetary system in which the Central Bank and power of the purse is essentially in foreign hands (because there’s no federal government, no central Treasury and the ECB is essentially a foreign Central Bank).
It’s great to see that we’re making progress in understanding all of this (and curious that Dr. Krugman has new found understanding after engaging with me on a topic I’ve been very vocal about). And while Dr. Krugman’s article does an excellent job dispelling many of the myths regarding the Euro currency, we could have all saved a lot of time, energy and pain if we’d just listened to the Post-Keynesian economists like Wynne Godley and Warren Mosler who have been saying this for years.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.