Home » Currency War » Welcome to the Currency War, Part 12: Bankrupt Rome and Soaring Euro-Bonds

Welcome to the Currency War, Part 12: Bankrupt Rome and Soaring Euro-Bonds

by John Rubino on February 28, 2014 · 18 comments

Only in a world totally corrupted by easy money could the following two things be announced on the same day. First:

European Bonds Surge as ECB Stimulus Confines Crisis to Memory

Yields on the euro area’s government bonds have never been lower as the potential for extended European Central Bank stimulus helps exorcise memories of the region’s sovereign debt crisis.

The bond-market rally is broad based, encompassing both core economies such asFrance and also peripheral markets including Greece, which was pushed to the brink of exiting the currency bloc during the region’s financial woes. Another of those nations, Portugal, took a step toward exiting an international bailout program today as it bought back bonds, while Italy, supported in the turmoil by ECB bond purchases, sold five-year notes at a record-low rate.

“Investors are starting to look at the non-core European bond markets as a viable investment alternative again,” said Jussi Hiljanen, head of fixed-income research at SEB AB inStockholm. “Further ECB actions have the potential to maintain the tightening bias on those spreads,” he said, referring to the yield gap between core nations and the periphery.

The average yield to maturity on euro-area bonds fell to a record 1.6343 percent yesterday, according to Bank of America Merrill Lynch indexes. It peaked at more than 6 percent in 2011, the data show.

Italy’s 10-year yield fell seven basis points to 3.47 percent after touching 3.46 percent, a level not seen since January 2006. Portugal’s 10-year yield dropped four basis points to 4.81 percent and touched 4.78 percent, the least since June 2010, while Ireland’s two-year note yield and Spain’s five-year rates dropped to records.

Then, at about the same time:

Rome days away from bankruptcy

Eternal city warns it will go bust for the first time since it was destroyed by Nero

Matteo Renzi, the Italian prime minister, came under pressure on Thursday as the city of Rome was on the brink of bankruptcy after parliament threw out a bill that would have injected fresh funding.

Ignazio Marino, Rome mayor, said city services like public transport would come to a halt and that he would not be a “Nero” – the Roman emperor who, legend has it, strummed his lyre as the city burnt to the ground.

Marino said that Renzi, a centre-left leader and former mayor of Florence who was only confirmed by parliament this week, had promised to adopt urgent measures to help the Italian capital at a cabinet meeting on Friday.

The newly-elected mayor faces a budget deficit of 816 million euros ($1.1 billion) and the city could be placed under administration if he does not manage to close the gap with measures such as cutting public services.

“Rome has wasted money for decades. I don’t want to spend another euro that is not budgeted,” Marino said, following criticism from the Northern League opposition party which helped shoot down the bill for Rome in parliament.

The draft law would have included funding for Rome from the central government budget as a compensation for the extra costs it faces because of its role as the capital including tourism traffic and national demonstrations.

Other cash-strapped cities complained it was unfair. But Marino warned there could be dire consequences. “We’re not going to block the city but the city will come to a standstill. It will block itself if I do not have the tools for making budget decisions and right now I cannot allocate any money,” he told the SkyTG24 news channel.

Marino said that buses may have to stop running as soon as Sunday because he only had 10 percent of the money required to pay for fuel in March.

He added: “With the money that we have in the budget right now, I can do repairs on each road in Rome every 52 years. That’s not really maintenance.”

How is it that Italy is able to borrow money at low and falling rates – which indicates that borrowers are confident of its ability to pay its bills – while its major city, far more important to that country than New York or Los Angeles is to the US, slides into bankruptcy?

The answer is that Rome is irrelevant in comparison with two other facts. First, Europe is slipping into deflation, which generally leads to lower bond yields. Second, the European Central Bank is virtually guaranteed to respond to fact number one with quantitative easing on a vast scale.

So the bond markets, far from rallying on the expectation of a eurozone recovery, are rising in anticipation of the opposite: a new round of recession/deflation/instability that forces the abandonment of even the pretense of austerity and the adoption of aggressively easy money.

In this scenario, a Roman bankruptcy is actually a good thing because it pushes the ECB, Bundesbank, Bank of Italy and the other relevant monetary entities to stop dithering and start monetizing debt in earnest. Once it gets going, the goal of the program will be to refinance everyone’s debt at extremely low rates, push down the euro’s exchange rate versus the dollar, yen and yuan, and shift the currency war front from Europe to the rest of the world. The race to the bottom continues.

The rest of this series is available here.

  • Willy1964

    O.M.G. This clearly proves one John Rubino consistently fails to understand the true nature of Deflation.

    Rising interest rates leads to lower bond prices and that’s called Deflation (=destruction of credit).

    • Bruce C

      I agree. Debt monetization does not solve any problems. However, it does serve to extend things which is what all the world’s politicians and financial authorities can do. And there may be another trick in the works too: The central banks can write-off the bonds they have accumulated thus reducing the burden on those bond issuers and devaluing the currency at the same time.

      • Willy1964

        I agree. But then we’re talking Hyper-Inflation.

        • Bruce C

          Maybe, but “hyper inflation” is more of a social event than an economic one. It remains to be seen just what it will take for sentiment to change for a critical mass of people/investors. As this piece illustrates “most” investors are still feckless and compliant, evidently thinking that central bank backing of sovereign bonds eliminates any credit risk and maybe currency risk as well because of ever-present deflationary pressures.

          • Bruce C

            Also, to add to the above, even if central banks declared a debt jubilee on all of their holdings I’m not so sure most people would understand the implications. They haven’t gotten it so far. Basically there would suddenly be, say, $20 trillion less debt/credit backing the global money supply. That should be inflationary, especially since governments all over the world would then have clean balance sheets and a laundry list of new boondoggle projects to invest in. But at the same time, given the mentality of the day, that could be considered “bullish” too since there could be new round of government largesse. It won’t end until it does.

          • Willy1964

            No. That’s (Hyper-)DEFLATION !!!!!!!
            A LOT OF people simply haven’t wrapped their head around what the impact is of both Hyper-Inflation & Hyper-Deflation. The weird thing is that even Hyper-Inflation is EXTREMELY Deflationary !!!!

          • Bruce C

            If you are defining “deflation” as a reduction in credit (and “inflation as an increase in credit) then I would agree. However, “Hyper inflation” usually means that prices escalate exponentially, regardless of changes in credit. I thought that’s what you meant in response to my comment about central banks writing-off their bonds. In that case – yes – credit would vanish which is deflationary by that definition, however, prices would be expected to increase because that would effectively create a windfall of free money for all the lucky bond issuers. It would have a similar effect to a bank that discharges its home mortgages and allows the mortgagers to keep their houses: Suddenly all those lucky new home owners would have an increase in their discretionary income by the amount of their old mortgage payments. That would increase the amount of money available to buy the same amount of other goods and services, thus prices would rise.

          • Willy1964

            No. it’s deflationary because then the assets of banks are reduced as well. It shrinks the bank’s ability to pay out its depositors, at the same time. Then one Bruce C. isn’t able to collect all his money from the bank. Then Bruce C. would only get say $ 40 instead of say $ 100. Or nothing at all. It decreases Bruce C.’s wealth & purchasing power. Less tax revenues for the gov’t. Very deflationary.

          • Bruce C

            Rather than address all of that, just forget about the regular bank analogy. The Federal Reserve bank, or any central bank that can “print” its own currency, does not have any of those constraints.

            Being a central bank is like having your own counterfeiting machine. You can print up a bunch of bills and then lend them to someone. At any time, however, you can choose discharge the loan and not require your borrower to repay you. In that case the borrower has the currency – or has spent it already – and you just have your counterfeiting machine ready to print more bills when you want them.

            Or, in balance sheet terms, your assets before the currency is loaned consists of the c. machine, some paper, ink, etc. and a pile of counterfeit bills, and your liabilities are zero, let’s say. The borrower has nothing; no assets or liabilities, say. Then when you loan the money to the borrower, your “assets” increase by the amount of the loan (because you think you’ll get it back some day) but so does your “liabilities” because you no longer have the pile of bills. (It’s really just a book keeping entry to balance the asset.) On the flip side, the borrower now has the currency and a balance sheet asset equal to the amount of the loan, but also the liability of owing you the money.

            Now, upon you choosing to discharge the loan, your “loan” asset vanishes (goes to zero) because you forfeit its return. The borrower then suddenly has only the currency asset but no liability because the loan was forgiven. “Globally” assets balance liabilities in the transaction.

          • Chris

            I agree. This is what I’ve been talking about for a while and trying to wrap my brain around. In the USA, Congress spends money that it doesn’t have by issuing bonds and selling them to the banks. Then the Fed (through QE) creates money out of thin air and gives it to the banks in exchange for bonds. The banks now have the cash to spend or loan out. The bonds (the government’s debt) piles up on the Fed’s balance sheet. Everybody knows that the US government will never be able to pay that debt back, so the Fed just lets those bonds mature and they disappear. It’s the perfect racket. The government can spend as much money as it wants because the Fed just prints the cash. It’s inflationary as long as the amount of cash created is greater than the amount of wealth that is disappearing (being consumed) by the country. But, as that wealth is consumed, more cash needs to be created in order to fund the government’s expenditures. We’ve long since passed that point, so now its just a matter of time…

          • Bruce C

            Yes. Thank you. And if you don’t mind I just want to clarify one point..

            It remains to be seen if the Fed (or any other central bank that has monetized debts) will allow those bonds to mature because that would ultimately require the re-payment of the principal which would be a burden to the bond issuers (i.e., US taxpayers via the US Treasury in the case of Treasury bonds.) To avoid that the Fed – at least in theory – could discharge those loans so no principle (or interest) need be repaid. By doing this currency devaluation/price inflation would result while total debt would decrease, which is one way to solve the current problem of “too much debt and not enough growth.”

          • pipefit9

            I agree with Chris’ assessment. As long as cheap oil was propping up the petro-dollar as the world’s reserve currency, this system was sustainable. With cheap oil, you have the world’s most efficient fuel doing all sorts of work, so who cares if the petro dollar issuers (fed. reserve) are skimming a bunch of profit by creating dollars from nothing?

            But we passed peak cheap oil ten years ago, and now oil is still a great fuel, but it is expensive to find and produce. Add on the burden of the petro dollar system skimming its share of the profit, and you have $3.50/gal gasoline.

            The only question is how does this unwind? Everybody and their uncle is predicting a crash, either sooner or later. However, it is also possible that it is a long drawn out affair, with gasoline going up 50 cents a gallon per year for the next ten or 15 years.

            Bruce C is correct about hyper inflation being social in nature, and the masters have some very powerful tools to stop the sort of panic that would lead to the dumping of dollars. The main thing they don’t want is the trillions of dollars outside of the USA to come back here. It might take some creativity to block those foreign held dollars, but these guys are long on creativity.

          • Willy1964

            No. By performing QE the FED has increased the amount of credit to the banks. It’s NOT (literally) printing money (yet). That’s why the gov’t still come up with tax payer’s money to pay interest & principal to the FED.

          • Willy1964

            No. It’s still destruction of credit/debt and therefore deflationary.

  • Cooper

    I noted you included a link to Peter Shiff at the end of this article. I did read his first book. Peter was good a predicting trouble and for that reason alone it is a good idea to read and follow his work. But as far as protection leading into that trouble, he didn’t do as well. For example, he recommended things like good utility stocks outside of the US, like Australia for example. But when things fell apart in the US, they fell apart all over including Australia. Hence, you got hit when the stock fell 50% (as they did in the US) but then you got hit again when the currency fell 35% as well. A double hit. I would read Peter’s work, but use caution.

    • Fabian

      Yes, P. Schiff is correct generally on his judgement of the situation but he is very black or white on the solutions. It’s never that simple. Prudence is warranted.

      • MacFly1

        Yes, Pete’s often right but he is selling products, after all.

  • MacFly1

    Cut the pensions, Rome. Its the only way.


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