I said earlier we are in a "doom loop": if Spain is forced into asking for a full bailout, Italy will be in play. That means the chances for a full-scale euro breakup (forget about Greece) increase dramatically. (See: The Doom Loop — Spain Puts Italy Into Play)
The logic is fairly simple:
1) The economies of Spain and Italy are continuing to deteriorate; governments are taking on more debt, private sector deleveraging continues, unemployment is still rising, and real wages are declining;
2) even though domestic consumption is down, most southern European countries are continuing to import more than they export;
3) Spain is heading toward a full bailout, which means Italy is; this greatly increases the chances the euro will break up;
4) the European bailout funds (EFSM & ESM) are not big enough to bail out both those countries;
5) the current, "German" approach to the problem (austerity, higher taxes and more central authority control of budgets) will not work due to pushback from southern Europe;
6) the attempt by southern European countries to bring back "pro-growth" policies (meaning the right to borrow even more money at far lower rates than the markets are offering now) is not feasible any longer; private investors will either refuse to finance these countries, or they will demand yields that the countries cannot afford;
7) the only way to save the euro is for the ECB to directly intervene via large-scale bond purchases, even if it is through the secondary markets. The ECB has not resumed its purchasing of government bonds, but will be forced to do so.
The only alternative to ECB bond buying I can see is the creation of some kind of "redemption fund" to deal with all the legacy debt; but where will that money come from? The ECB will end up backstopping that fund too. Who else can offer rates at the three percent the governments want?
Bottom line: all roads eventually lead to the ECB. Beyond that is default.
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