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Spain and the Western Financial System on the Brink

Interest-Rates / Eurozone Debt Crisis Jun 19, 2012 - 04:01 AM GMT

By: Mario_Innecco


This weekend the world kept a close eye on the Greek parliamentary elections and the big worry, from a EU establishment perspective, was that the a victory by the Coalition of the Radical Left or SYRIZA would result in market turmoil today. SYRIZA, under the leadership of Alexis Tsipras, did not win and the New Democracy party triumphed and as a result Greece is now expected to stay the course as far as the EU bailout plan is concerned. So this should have been great news for the markets right? Europe could now move ahead and sort its sovereign debt crisis out.

That is what we were led to believe but the reality of what happened in Europe today was quite disconcerting as the markets turned their eyes towards the Kingdom of Spain and gave it the thumbs down despite the much hyped €100 billion bailout of its major banks just a week before. Maybe the markets now realise that one can not solve a debt problem by piling on more debt? We at For Sound Money think the markets are quickly losing faith in the Kingdom's ability to not only pay back its debts but also service its debts.

Today the Spanish 10-year government bond or bono yield settled at a post EMU (European Monetary Union) high of 7.158% or up 28.4 basis point from Friday's closing of 6.874%. The short end of the yield curve reacted even more negatively as the 2-year yield spiked 45.6 basis points higher to 5.445%! This 2-year yield had dropped from 6.12% at the end of November 2011 to a low of 2.15% in the beginning of March this year. This 400 basis point or 4% drop came as a result of the ECB's (European Central Bank) Long Term Refinancing Operations or LTRO through which the central bank lent a total of €1.018 trillion to European banks at a very low rate of 1% for three years. The first of these financing operations took place on December 22, 2011 and the second leg of of the LTRO came on the 29th of Febraury when €529.5 billion was borrowed from the ECB. As one will notice the Spanish 2-year yield bottomed just a few day after this second LTRO.

The purpose of the LTRO was to help the European banks and at the same time drive government bond yields lower as Spanish and Italian banks would borrow at 1% for 3 years from the ECB and lend (buy government bonds) to their respective govenments at a higher rate. This LTRO was supposed to be a win-win deal as the the Spanish and Italian government borrowing costs would be driven down by their banks buying their paper and the banks would at the same time make a profit as dropping yields of their government bond holdings would mean rising prices of their holdings. So just over three months since the last LTRO Spanish yields are exploding higher once again and that means the value of the Spanish government bonds are crashing which also means that the financial health of the Spanish banks is quickly detereorating. Not surprisingly the Spanish IBEX-35 index finished down 2.965 today and the financials led the way with a drop of 4.22%.

It is clear that the ECB's LTRO strategy has been an "epic fail" as my teenaged daughter would say. It looks to us here at For Sound Money that the post Bretton Woods "Fiat Dollar" system is in critical condition as the Spanish domino seems very close to falling on to the Italian domino.

The ball is your side of the court central bankers and we are not even sure you will be able to hit it back over the net!

The Spanish 10-year yield chart. (Bloomberg)

By Mario Innecco

At ForSoundMoney we stand for a hard currency. We believe in a monetary system based on commodity money and a free-market banking system where central banks are non-existant.

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