Merkel's Dilemma; Eurozone Borrowing Costs Hit Record; Expect Sovereign Defaults

The Spiegel Online shows the severe problem facing facing Germany in terms of investments at risk, the enormous amount of money owed German banks by the PIGS (Portugal, Ireland, Greece, and Spain).

Please consider Merkel's Dilemma, Chancellor Faces Tough Sell on Irish Bailout

For the second time in just a few months, Angela Merkel will have to explain to voters why Germany must bail out a fellow euro-zone member state. Skepticism is growing -- amongst voters, in the media and within her party. Many want to see Dublin raise its low corporate tax.

Germany will be the largest guarantor of the bonds that the European Union rescue fund, which was set up in the spring, will likely issue to borrow money to help stabilize Ireland. Unofficially, there is talk of guarantees worth an estimated �90 billion ($122 billion), with Germany's share possibly amounting to around �25 billion.

In order to secure popular acceptance for a bailout, Merkel and her colleagues want to put pressure on Dublin to implement a tough reform program that would also address the issue of government revenues. Ireland's low rate of corporate tax, which is just 12.5 percent, has attracted many companies to the country. For the time being, the German government has not revealed what it wants from Dublin in terms of concrete demands.

But many people in Merkel's conservative-liberal coalition want Ireland to raise its tax rate. "It is unacceptable that countries such as Ireland poached companies in Europe through low tax rates only to rely on aid from other countries during a crisis," said Michael Fuchs, a CDU expert on small- and medium-sized enterprises. Ireland must take action on both spending and revenues and aim for a "European level" for its corporate tax rate, Fuchs told SPIEGEL ONLINE.

Misplaced Blame on Ireland's Corporate Tax Structure

Note the repeated blame placed on Ireland's corporate tax structure.

The blame really should be placed on German banks stupid enough to fund Ireland's property bubble.

Investments at Risk




Ireland's Budget Deficit 10 Times Maximum Allowed Under Maastricht Treaty



There is much more in that Spiegel Online column, please give it a look.

In what way is Ireland responsible for that debt structure? Did Ireland put a bazooka to Germany's head demanding those loans?

If not, and the answer is "not", then why should either German citizens or Ireland's citizens have to pay for a bailout of Ireland?

German, UK, and US holders of Irish debt (banks) should have to (and will have to) take a big haircut on that debt. It's as simple as that.

Eurozone Borrowing Costs Hit Record

One look at the above is all you need to understand to figure out this would happen: Eurozone borrowing costs hit record

Irish, Portuguese and Spanish bond yields surged to their highest points since the launch of the euro, as traders said even some of the bigger eurozone countries could soon be affected. Matt King, global head of credit strategy at Citi, said the danger was the selling could develop a momentum of its own.

Myles Clarke at RBS said: �Some people want to put on a just-in-case euro break-up trade and they�re looking for any way to do this. You can�t do trades in any size in the stressed peripherals like Ireland or Spain, so people are looking for what else might work.�

A senior trader at a US investment bank added: �I�m freaking out. The investors who were bottom-fishing last week are all selling this week.�

Irish 10-year bond yields rose above 9 per cent, Portuguese yields jumped further above 7 per cent � a level Lisbon says is not sustainable � while Spanish yields rose further above 5 per cent. The euro dipped towards two-month lows, falling for the fourth day in a row.

The clearing house increased the charges or margins from 30 per cent to 45 per cent above normal requirements to trade Irish bonds. This makes Ireland�s banks, which use sovereign bonds to raise money for funding, even more dependent on the European Central Bank.

Destabilizing Rescue

It's clear that Ireland needs many reforms, but raising its corporate tax rate now sure does not appear to be one of them. That low tax rate is the only possible way Ireland can maintain any growth edge that would allow it to dig out of its hole.

Moreover, it's important to understand that the alleged "bailout" is nothing more than a moderately-high-interest loan with unsound-strings attached.

Those strings are more like anchors. They put added stress on the system. Even if, the ECB comes to yet another rescue for Portugal and Spain (and some complete fools are calling for preemptive ECB action to do just that), the whole structure of these bailouts is destabilizing.

What cannot be paid back, will not be paid back. Thus, lending Ireland, Greece, Spain, and Portugal more money under onerous terms is the height of extend-and-pretend stupidity.

Expect sovereign defaults.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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