Too European to Fail

With fears mounting that one or another euro-zone country may default, yield spreads on government bonds between EMU countries have reached record highs. But the panic that EMU may disintegrate is overdone: rather than a default and subsequent exit from the euro zone, the member states are more likely to violate the EU Treaty and bail out a fellow member state.

BERLIN – Among investment bankers, there is renewed speculation about the possibility of a country leaving European Monetary Union – or being pushed out. Rating agencies have downgraded Portugal, Greece, and Spain, owing to their poor prospects for economic growth and weak public finances. Ireland has been assigned a negative outlook and could soon suffer a downgrade as well.

With fears mounting that one or another euro-zone country may default, yield spreads on government bonds between EMU countries have reached record highs. For some time now, Greek ten-year government-bond yields have been about 300 basis points above German yields. This is a sign that investors now see a significant risk of a Greek default or of Greece exiting from EMU and redenominating its government bonds.

But the panic that EMU may disintegrate is overdone. Rather than a default and subsequent exit from the euro zone, the member states are more likely to overrule a fundamental principle of EMU and bail out a fellow member state.

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