Approaching Germany's inflection point

Last night bond market traders suddenly woke up to where the money must come from to rescue Greece, Spain, and Italy and other broken European economies – it's Germany.

Or let's put it another way. The global banking system currently depends on Europe not falling apart. It may not be under the same threat as occurred during the global financial crisis but there will be enormous banking losses if Europe splits. The world's banks require the Germans to spend all the post-war wealth they have built up to rescue the Greeks, Spaniards and Italians.

Some bond traders are questioning 'why would you accept a 2 per cent yield on 30-year bonds in a country that was being forced to destroy its wealth?' German bonds last night had their biggest drop since 2009, with the yield rising 0.13 per cent to 2.18 per cent. That's still a low yield.

If the German bond yields keep rising and therefore German bond values keep falling, the average German will suddenly realise that the vision of Germany leading a united Europe means that Chancellor Angela Merkel is risking their savings and the country's wealth.

The trouble is that if the euro splits – perhaps by Germany leaving the euro – German banks are among the biggest losers. As it is, no one has looked too closely at the German bank balance sheets, which almost certainly have large paper losses not brought to account. Accordingly, the German banks will be pressing their chancellor not to pull the plug on Europe.

And as Oliver Marc Hartwich explained, Germany's central bank has effectively increased its loans to other European central banks from €462 billion to €699 billion in the last eight months (Believing in Europe's financial tooth fairy, June 12).

The Germans are getting closer to the point of no return. The cost to Germany of a European rescue helps explain why Merkel does not want to be the leader that destroyed what past leaders built up unless Germany ends up with much greater control over the other European countries.

And of course, while the Greeks, Spaniards and Italians want the German money they do not want to change their lifestyles any more than is absolutely necessary. And they will not forgo their independence.

So the pressure is on Germany to simply deliver the money and save its banks.

Footnote: The bad US retail sales would normally spook markets but the bulls are excited because bad news makes a third quantitative easing more likely. These US money-printing exercises do not help the economy much but they are a share and commodity traders' picnic because that's where most of the money ends up.