Executive Summary

• European banks have shifted their priority from supporting national governments to combating capital flight
• Hollande's policies are accelerating France's path to insolvency, thus advancing the date of the Eurozone collapse
• The euro can fall MUCH farther from here
• We are currently at a stalemate being forced by Germany, but it will soon end and downward momentum will quickly build

If you have not yet read Part I, available free to all readers, please click here to read it first.

In Part I, we examined the economic pressures likely to blow the Eurozone apart and concluded that there is increasing disquiet in Germany over the cost of supporting stricken economies and her increasing reluctance to write open-ended cheques. The first creditor country to leave will probably be Finland, or perhaps one of the other smaller members less committed to the Eurozone project. Let's now explore how this might come about, along with the consequences for the rest of the world.

Sovereign Debt Markets

It is obviously not possible to anticipate tomorrow’s events with any certainly, but we can lay down some pointers, the most obvious of which is changing yield levels in sovereign debt markets. Let's focus on Spain because she currently causes the most concern.

Before mid-November last year, Spain’s ten-year bond yield had run up to 6.58%, up from the 4% level that prevailed before her debt crisis became an issue (see chart below). At end-November, the yield fell in anticipation of the ECB’s first long-term refinancing operation (LTRO), because Eurozone banks used some of the money to arbitrage between Spanish bond yields and the considerably lower cost of funding from the ECB. This way of making money is encouraged by Basel 3 rules, which define short-term sovereign debt as being the highest quality, so no haircut is applied. This regulatory quirk has been conspiratorially used by the ECB, commercial banks, and governments themselves to ignore fundamental lending realities.

From the first LTRO, Span's banks took up €105bn, Italy’s €110bn, France’s €70bn, Greece’s €60bn, and Ireland’s €50bn. Much of this money was required for the banks’ own liquidity and to cover deposit withdrawals and loan losses, but there is no doubt that significant amounts of this LTRO money went into government bonds.