It always seems that politicians like to over promise and under deliver until the crisis hits a crescendo. In order to assess where we are in the crisis, we have to find some meaningful metrics. One measure is the short-term Libor OIS spread (LOIS) as an indicator for bank liquidity and banking credit risk. The other measure is the credit default swap levels of the troubled European countries which measure the probability of default in each sovereign debt market. We can focus on spiking levels of individual countries or try to blend the CDS levels in a meaningful way. If we look at the nominal GDP of each of the PIIGS, we can come up with a relative weighting in global importance:
Spain and Italy dwarf the rest of the PIIGS
We can use these weightings to look at a blended index of the PIIGS’ credit default swap levels since the beginning of 2010:
The graph shows that 2010 was a mere speck of a sovereign credit risk flare with most of the focus on tiny little Greece. The true fear started in mid-2011 and escalated to a frenzy at the beginning of August. We have witnessed a full contagion as Spain and Italy have fallen to the fear mongering. The politicians created a very short-lived rally at the end of October with the announcement of the €1 Trillion plan, but since then the reality has sunk in that little has changed.
What kind of discomfort do the German and French citizens have to endure in their brokerage accounts before they A) dissolve the Euro or B) let the printing presses run? Which of the two options creates the most amount of pain? My own guess is that option A is the cleanest and least evil. Let the debt-burdened countries reset with their own devaluing currencies, take their punishment quickly and start over. Unfortunately I believe that option B will come to pass. Germany will be able to take its pound of flesh out of the other struggling eurozone member nations via a strong central position in the new, all-governing, all-ruling, European Federal Reserve. The citizen savers will believe that a catastrophe was averted by their politicians, but in reality the catastrophe was turned into a slow bleed via taxation through inflation.
