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The PIGS have their problems, but Europe is not melting down



Portugal, Ireland, Greece and Spain are still having sovereign debt problems. Even though the EU is working hard to patch over the problems, credit default spreads for these issuers have risen significantly. Once again the world is worrying whether these problems will lead to the collapse of the euro and/or serious problems for European economies.


As this chart of swap spreads suggests, the problems, while serious, are not nearly as bad today as they were at the peak of the global financial crisis in late 2008. Moreover, the systemic risk posed by the sovereign debt problems of the PIGS is even less today that it was in early summer. 


This chart of the euro vs. the dollar suggests that the euro is far from being on the verge of disintegrating. Indeed, the euro is doing pretty well relative to the dollar, and is not too far below its all-time high against the dollar. 


This chart shows that the yield on Greek short-term debt is elevated relative to German debt, but far less than it was last May. The bond market is thus telling us that there is a decent chance that Greece will default, but that is by no means a done deal, and even if Greece were to default, it would not likely bring down the core of Europe. German yields were much lower last summer when the market was very concerned that Greek contagion could result in a much weaker European economy. Today, German 2-yr yields are about twice the level of US yields, suggesting that the prospects for European growth are actually better than for the US. In that regard, I note that Germany's DAX index today is at a post-crisis high not seen since the second quarter of 2008; that's further support for the idea that Europe on balance is doing OK, despite the problems of the PIGS. 


As this chart shows, the yield on Irish 2-yr government bonds has dropped significantly in the past week or so, suggesting that the financial rescue package being put together for Ireland has substantially reduced its near-term default risk. The yield on 10-yr bonds has also fallen of late, but remains very elevated at just over 8%. That puts Irish bonds on a par with junk bonds, which on average are currently yielding 8.2%. Ireland is definitely a credit risk, but it is not a portent of great financial destruction or impending economic collapse.

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