Merk Commentary: European Bonds for Italy?
Axel Merk, Portfolio
Manager, Merk Funds July 11, 2011
www.merkfunds.com/merk-perspective/insights/2011-07-11-european-bonds-for-italy.html?type=mi European countries have been too slow in
embracing structural reform and European financial institutions too slow in
repairing their balance sheets; the markets are not waiting for them to get
their acts together. Italy has become the most recent focus; what's different
about Italy? It has a positive primary balance: before interest payments, the
Italian government is generating a surplus of 1.8% as a percentage of GDP.
Except, of course, with a debt to GDP ratio of 119%, after interest payments,
that surplus becomes a deficit of -4.6% of GDP. With other peripheral Eurozone
countries, bond markets have already pressured governments to engage in
structural reform. While Italy could and should be more aggressive in
engaging in further reform, a primary surplus is what other weak Eurozone countries are dreaming of. In our assessment, the current dynamics may
finally lead to a large-scale introduction of pan-European bonds. European
policy makers may decide that any country that meets certain criteria, such
as a primary account surplus (eventually watered down to a primary deficit
not exceeding x%) may be a beneficiary of bonds
backed by the entire Eurozone. The market is extremely hungry for such bonds, as
they promise high quality and liquidity. Germany may be the most reluctant to
embrace such bonds, keenly aware they might challenge German bunds’ benchmark
status for Eurozone bonds down the road. With Italian markets under pressure, pan-European
bonds appear to be an ever more likely step in an effort to achieve a more
"comprehensive" solution for weaker European countries. While such
bonds may be an extension of the European Financial Stability Facility, a key
difference to tap into the bonds may be that they come with fewer, if any,
strings attached, potentially making them a general purpose funding mechanism
down the road. To some it will be another bailout; to others, it will be
milestone towards close fiscal integration in the Eurozone. Axel Merk |
