There was in the past week an off-hand remark from Vladimir Putin to Angela Merkel that was referred – I believe it was in Die Welt:
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The Russian currency reserve holds mainly German sovereign bonds: “They have a terrible yield, but they are stable.”
It seems like everybody has missed the significance of that remark:
There is no shortage of German sovereign bonds. That is a remnant of the German takeover of East Germany.
The trick is that German sovereign bonds are taking over on a role as reserve currency. It is not going to be the Euro, but German sovereign bonds. Just look at Spanish sovereign bonds: They are next to impossible to sell. That is just like Greek sovereign bonds in the months before the default.
Countries other than Germany may issue sovereign bond till the cows come home; but there will be no takers. There is a lot of talk about Euro-bonds – which seems to be just that: Talk.
There will be no Euro-bonds without German backing. This means in practice that every bond in Euro must be guaranteed by Germany – one way or the other. This means Germany must carry the default risk or the bonds will be worthless/unsellable. Another way of putting it: A sovereign bond from a PIIGS country must be sold to Germany and financed by issue of German Sovereign bonds – that are sellable.
But are there no limits to German bonds and their marketability? That is the point: Apparently not! Just look at how the deposits in Spanish banks have fled into German sovereign bonds – if that is not debasing the Spanish “coin” or rather devaluing the Spanish currency.
If every country – and investor is dying to buy German sovereign bonds there is no limit. Just look at the interest rate: 1 ¼ % to 1 1/3 % on a 10 year German sovereign bond. Compare this to a Spanish bond with an interest rate of 6-7%: The German bond is accepted as coin – the Spanish is just a washer. In fact Spaniards (to abuse them as a bad example) have lost the ability to coin!
There is no Euro issued without ultimately having backing in the Bundesbank. So why not stop the charade and stop trading toilet paper?
On the other hand it opens near to unlimited credit for Germany – and thus the Euro. Others might issue bonds – with a German backing: This backing might be forthcoming; but at a price!
This price is either a minor increase in interest or toeing the line in economic policy. The amount of money will depend on the willingness of Germany to print German sovereign bonds – simply because a creditor will rather have a German bond than a Spanish (almost at any cost).
The Euro is not going to break up – it will become what it in reality always was: The Deutsche mark. Every bum may write an IOU on the back of a cancelled lottery ticket; but very few will accept that as currency – they will much rather have a 100 dollar bill. And a 100 dollar bill is nothing but a US sovereign bond carrying no interest; but redeemable on demand. This redemption is now – as far as the Euro is concerned – not without a price.
Back to the Euro’s role as a reserve currency:
Normally a reserve currency demands that a nation is willing to run at a deficit for quite some time, and Germany isn’t doing that. But if/when Germany backs other countries deficits they “borrow” these countries deficits. That can be done, but at the price of said countries pay back: Germany owns Spain.
Germany never had the ambition of becoming an issuer of a reserve currency; but that was how the dice rolled.