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MOVING ON TO SPAIN

Spanish bond yields are hitting 8 year highs as markets look past Portugal and assume that Spain is soon to be on the chopping block.  Less than a week ago I asked if the Euro crisis was systemic?  In that note I highlighted Credit Suisse’s note citing 6.5% yields as the breaking point:

“(3) The situation in Spain is sustainable for now. This is critical because there is nearly €460bn of core European bank assets in Spain and Spain accounts for 11.5% of European GDP (70% larger than Portugal, Ireland and Greece together). The reasons the situation in Spain looks sustainable is that: on current bond yields, interest payments are 3.7% of GDP (if all of debt is funded at the long end), compared to 6.7%, 7.4% and 16.7% in Portugal, Ireland and Greece – and, critically, they are below the long-term nominal GDP growth rate. Spain looks sustainable until bond yields rise to 6.5% from 4.7% currently.”

Here we are just a week later and yields have surged almost 1%:

The problem with IMF intervention and bailouts is that the issues become contagious.  Once one group of bondholders receives a bailout the next group begins to anticipate a bailout.  Bond vigilantes attack the next weakest link in order to force markets into saving them.  We saw this during the Asian financial crisis, during the US financial crisis and now in Europe.  Spanish bondholders would be insane not to demand higher yields and a guarantee of some sort.  This likely means the Spanish endgame is moving ahead as I’ve long expected.  The rot that is the single currency Euro system continues to be exposed.  Those who have voiced a desire to move back to the gold standard need look no further than the Euro system for evidence of what that world would look like.

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