DC Comics
Comic-Con, the international comic book and entertainment convention, has just ended its annual festival in San Diego. Enthusiasts the world over gathered there to celebrate the fictional worlds that bring us all so much joy, and dread. One such fictional universe created decades ago by DC Comics, Bizarro World, has infiltrated the sovereign debt of nations around the world. Just like in the Superman story, where Bizarro exhibits the opposite of every Superman trait, many yields are painfully low – even though they have greater risk. This is a violation of the natural order of our capital markets (where higher returns justify taking higher risk). But, just like in the comic books, an alternate universe lasts for only so long before reverting to normal enemies.
Today, German 10 Year Bunds – hey, that’s German for Bonds – pay investors 0.57%. Comparatively, US 10 Year Treasury bonds pay 2.33%. In a normal universe, where higher risk equals higher reward, US debt should be considered far riskier than its German counterpart. Putting politics aside – and, that’s a very big aside – do investors genuinely believe that Germany is so much less risky than the US? Global investors may be severely discounting the underlying risk associated with Germany’s die-hard championing of the European Union.
Simply put, Germany is now the financial backer of the entire EU. France is not big enough to fill the very big shoes soon to be vacated by the UK. This week Greece successfully issued billions of new debt, which many applauded, especially after defaulting so recently. How is it that US corporate junk bond spreads are almost double that of the German-Greece spreads (see chart)? This is pure madness. If the markets were assigning true risk (without all the monetary meddling from the ECB), German debt should be yielding much higher, thus pushing up the junk yield rates from Greek debt. These two economies – one strong, one very weak – are now deeply linked, as German Chancellor Merkel has proclaimed the EU’s stronger together forever outlook.
The UK is having a hearty laugh. Greece continues to lose ground on tax revenue collection, while amassing further debt (per recent IMF reports) – and all is back-stopped now by Germany alone. How long before the drowning man takes down even the most adept swimmer? Expect the ECB to keep guns blazing. If they’re lucky, Draghi will marshal enough support to propose a game-changing, unifying fiscal policy mechanism. Marrying fiscal and monetary policy-making across all 23 EU member nations within closely aligned EU governing bodies is the ECB dream. Much like how the US Federal Reserve manages the economy in close collaboration with the US Treasury and Congress. Achieving this with so many unequal EU member interests, however, seems more fantasy, but it will be the only way the EU can turn their Bizarro World back into Earth as we know it.
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