Who will save plucky little Belgium? In yet another insult to the single European currency, the bond markets are now testing Belgium's defences. The country that hosts Europe's seat of economic government suffered a sharp increase in the cost of its borrowing on Tuesday with the yield on Belgian 10-year bonds rising to almost 1.4 percentage points higher than the equivalent benchmark German bond. Italian sovereign debt was came under pressure again, rising to a record spread of 1.86 percentage points against the bund.
This is a fiscal and monetary crisis, not the First World War, and no one analyzing the debt markets expects Belgium to default. It is not in the front line in the way of Ireland with its insolvent banks and dud real estate loans. The raw economic numbers suggest that Belgium shouldn't be in the front line despite having the third highest debt level in the euro zone after Greece and Italy, reaching a level equal to the Belgian economy this year. Its public sector deficit is only expected to be 5 per cent per cent of GDP this year and Belgium didn't go on a real estate spree like Ireland or Spain; household savings are high. The Belgian economy is growing strongly, unlike Ireland or Greece.
Brave little Belgium; it explains why the Belgian treasury was able to raise €1-billion on Monday at an interest rate of 3.7 per cent while Ireland would be paying more than 10 per cent, assuming that any investor was willing to lend. This is not 1914, but it is about the testing of an alliance which has been found to be weak and lacking in leadership. Those euro zone politicians who complain that bond market speculators are mispricing risk by selling Portuguese, Spanish, Italian and now Belgian debt forget their silence years ago. Then, Portuguese and Irish bonds were trading within a hair's breadth of German debt yields but no one thought that was strange.
All that is happening is that euro zone member states are being judged, not as satraps of some Austro-Hungarian Empire but as free-standing nations with separate economies and distinct problems. They myth of an EU guarantee of member state solvency is shattered and on Wednesday the European Central Bank was back in the market buying Irish and Portuguese debt in a desperate effort to regain the initiative. The appalling truth is dawning in the markets that the EU has nothing left to protect the peripheral euro zone states but massive purchases of government and euro zone bank debt by the ECB; quantitative easing on a colossal scale - the printing of euros.
The ECB will have to do this if it is to avoid the restructuring of Irish, Portuguese and Greek sovereign debt and it will have to do this to prevent the flight of capital from the euro zone periphery. We are now in a situation where weaker European companies are at risk of refinancing problems due to being shut out of debt markets while the strong, such as utilities and energy companies, may fear that their cash flows will be targeted by desperate governments. A bailout of a major European sovereign, such as Spain, is politically impossible and even little Portugal may be a step too far for the German electorate. The fiscal attack on corporates may spread throughout the Club Med states, ruining their economic prospects as international investors strike these countries from any list of potential investment destinations.
In order to avoid these outcomes, it looks like the ECB will now have to print money like an alcoholic who has leapt off the temperance wagon to indulge in a final binge. Whether Germany is prepared to stomach such an outcome is doubtful. Soon the political sparks will fly.