By Protesilaos Stavrou on November 27, 2011

Explaining the last failed auction of German sovereign bonds

Image Source: Der Spiegel
In the midst of all the discussions around the ECB monetizing debts and the European Commission putting forward the proposal for the adoption of eurobonds, a very important event occurred in Germany, one that sends a clear message about the expectations of international investors regarding the fate of the euro and the future of Germany without it. On November 23 the German government attempted to raise fresh funding by holding an auction for 10-year sovereign bonds at just under 2 percent. The auction failed spectacularly as the Germans wanted to issue 6 billion euros of 10-year bunds but managed to sell only 3.64 billion.

Some might have seen this as a very bad sign regarding the fiscal finances of Germany and its ability to borrow at low interest rates. I for once, do not see it as such. I do not see the failed auction in Germany as a parallel to the run on Italian bonds were investors clearly consider Italy as insolvent. The way I interpret this, is that investors are now considering two things (i) either the collapse of the euro as a whole, (ii) or the reconstitution of a new Deutschmark or a new euro resembling the German currency that might as well encompass some of the countries that are similar to Germany, or whose industrial sectors have practically merged with the German one. In either case they expect that their bonds that will be denominated in euros will lose value, since the euro itself will be losing value under both scenaria.

If the euro collapses or Germany returns back to its national currency, it is well expected that investors will rush to buy the new German currency, thus leading to a sharp evaluation of it, with respect to all other European currencies and even vis a vis a potential notional "euro" that will be used a benchmark to facilitate the transition from the single currency to the national ones. The effect of this increase in the value of the new Deutschmark is that the debt (bonds) issued in euro will effectively become cheaper. Germany will be in the very advantageous position of paying old debts at a lower price without ever needing to impose any haircuts. Good for Germany, bad for investors who do not want to see their money being lost in a currency depreciation. Investors aware of this dynamic prefer to wait for the new German currency to come into being before investing their money in German bonds.

The confidence in the German economy has not been lost (something that holds true for many other eurozone member-states). All that happened was that investors realized that the possibility of the collapse of the Euro has increased dramatically. We shouldn't of course rush to produce definite conclusions about the future of either Germany or the euro, yet the structural flaws of the single currency have shown in several occasion that once a dynamic begins it can only gain momentum.

Explaining the last failed auction of German sovereign bonds | Protesilaos Stavrou

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