As euro zone talks, markets prepare for action

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In the euro zone we have gone beyond the need for verbal support. It's all about putting your money where your mouth is and that was apparent on Tuesday when Beijing promised "concerted action" to support the single currency by continuing to buy the bonds of peripheral euro zone sovereigns.

The comments from officials who said they were speaking on behalf of China's vice-premier Wang Qishan were widely reported but their effect was negligible, indeed in many cases negative. Following the Chinese declaration of love for euro debt, the yields on every benchmark peripheral sovereign widened, from Ireland through to Greece. As if to challenge the Chinese declaration of faith, Moody's put Portugal's debt on watch for downgrade on Tuesday after similar action on Ireland last week.

Where is the money? Even after the rescues and the recent agreement to amend the Lisbon Treaty to incorporate a crisis mechanism to bail out sovereigns, bondholders are still dumping their euro zone debt whenever a buyer emerges. If China was truly serious in its support for the single currency, it would have co-ordinated a big purchase to coincide with its statement. Instead, Portuguese yields widened again on Wednesday and Fitch, the rating agency gave warning that it might relegate Greece to "junk" within six weeks.

Anyone who has been following this long-drawn-out euro zone swan song might be surprised to learn that Greece was still regarded as "investment grade". The reason, of course. is that the rating agencies are frightened of the potential for regulatory revenge from Brussels if they make any statments or do any action that is other than banal in relation to sovereigns. The continuing enjoyment of investment grade by euro zone sovereigns is predicated on the notion that default is unconscionable.

But we now know that Germany wants a mechanism for a sovereign restructuring in which bondholders suffer "haircuts" to their right to recover funds. From the point of view of its biggest economy, the euro zone is no longer the Rock of Gibraltar, it is a club in which different members have different values and each looks after their own. Indeed it is beginning more like the boulder in the Myth of Sisyphus, were man is condemned to continue to perform meaningless tasks, such as rolling a rock up a mountain only to see it fall down when it reaches the summit.

Pimco, the world's biggest bond fund, has already cast its judgment on the credibility of the current crisis arrangement and it is simple. Adam Bosomworth, head of portfolio management at Pimco, told Die Welt, the German paper that investors simply did not believe that Ireland, Greece and Portugal could repay their borrowings. As a result they were seeking to shed their holdings whenever possible.These countries, said Mr Bosomworth should leave the euro, take advantage of currency devaluation to restore their economies on to a growth path and then rejoin the euro later.

A solution to the problem of insolvency must be found now, he said, not when the rescue loans come due in 2013. "Politicians can no longer close their eyes to the possibility of a state bankruptcy within the European Union. They must urgently find a solution to the problem of insolvency. 2013 is much too late."

With Greek 10-year debt trading on 12 per cent yields, the market is saying that default must be imminent and Pimco's view seems like a statement of the obvious.

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