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When Europeans turn their attention to what the markets are saying, it is usually because problems are brewing. A decade ago, as the euro-zone crisis flared up, politicians examined the “spread” between the annual interest on bonds issued by Italy or Greece compared to those issued by Germany, to gauge whether investors would prefer the thrifty southern countries. How nervous they were about giving the loan. Northern ones. More recently they were concerned about the short-term price of gas, often imported on ships, which was urgently needed to replace Russian methane flowing through pipelines. Such experiences have made policy types wary of markets, which they view as inherently unstable, “Anglo-Saxon”, and controlled. That’s a shame: there’s so much to learn from the signals coming from investors in everything from debt to currencies and much more besides. Politicians should listen.
First, a warning: The old curves whose signals they once paid attention to are no longer worth checking hourly. The spread between the southern countries and Germany’s relations is nowhere near the level of euro-zone panic these days. In some cases, such as Spain and Greece, it is because investors feel that the prospects for those economies have improved. However, in Italy’s case, there are still considerable concerns about how it can repay a huge debt pile, given its budget deficit of more than 5% this year and ho-hum growth prospects.
Investors will currently lend money to Italy at an annual rate about two percentage points higher than Germany. This does not reflect his optimism. In fact, the European Central Bank has signaled it is prepared to liquidate Italian bonds if other investors will not do so. Policymakers didn’t like what the markets were saying about Italy for once, and (perhaps wisely) blunted the signal partially instead. Still, there’s no escaping the fact that Italy’s debt is a crippling problem. The new loans pay nominal interest rates of about 5%, up from about 1% two years ago and the highest in a decade. As its borrowings are refinanced slowly at this level, this would cause substantial losses to Italy, worsening its debt position (although still high inflation may help reduce the real cost). Other countries also face similar headaches. A balanced budget in France is something that is talked about endlessly but rarely included (its last surplus was in 1974).
Information emerging from a new form of debt that investors are buying and selling is sending another message EU politicians may not want to hear: that their ambitions to create a closer union are not credible. The signal comes from the price of about €400bn ($423bn) of bonds issued by the EU to finance the economic shock in response to the Covid-19 pandemic. This new financial arrangement – of jointly contracted debt, not attributable to any single EU country – was hailed as a watershed of integration, a “Hamiltonian moment” that would take such lending further. Will go. (In fact the club has issued debt before, but on a much smaller scale.) A quick look at market data shows that investors think this grand project is a pipe dream.
The bonds are guaranteed by all 27 national governments of the EU, albeit in a somewhat circuitous manner. This could mean they should not be riskier to investors than Prudential Germany, the club’s safest debt. But the yields demanded by buyers are far higher, at times around the level of France or even Spain. Two lessons are being telegraphed here. One is that investors are indicating that more such joint debt issuances are unlikely to occur in the future, as many believed was inevitable. If the pandemic-era response is indeed a one-off, it would result in a decline in the total value of outstanding bonds as early as 2026. This reduces the ability of investors to buy and sell bonds over time, which in turn suggests they are now demanding higher yields as compensation for less liquidity. The second lesson is that markets treat the EU differently from a top-notch sovereign issuer like Germany or the US – the safest bet when it comes to lending money. Such governments have the power to raise taxes when they need money to repay creditors. In contrast, sending checks to the EU requires well-meaning requests from national capitals.
Another market that is relatively new is that of carbon credits – and the verdict here is much more rosy. In 2005 the European Union established an emissions trading system under which large-scale polluters such as power plants must pay for the right to emit carbon into the atmosphere. For years the price of these pollution credits remained at €10 per tonne or less. Such low prices gave dirty factories no incentive to invest in green technologies, and suggested that Europe was not serious about cleaning up its act. not anymore. The credit has risen since about 2018, briefly surpassing €100 earlier this year, and now stands at €81. This helps in filling the state treasury. Even better, it suggests that investors believe Europe’s environmental ambitions are credible. In recent days, voters in several rich countries, including Germany and the Netherlands, have criticized costly green policies. The markets, echoing the views of countless participants, are signaling that carbon credits actually have value – that is, the ambitious carbon-reduction agenda is here to stay.
The hardest market signal to fathom is the most basic measure of economic stature: the value of the euro against the mighty US dollar. Alas, that message is clear. The euro has depreciated by about a quarter against the greenback over the past decade, although this is higher than since the launch of its coins and notes in 2002. Many factors depend on currency prices, including interest rates. (The US is higher, which affects the dollar.) But over the long term the level of the currency is a crude measure of an economy’s prospects, its dynamism and capacity for innovation. For most Europeans the single currency is the biggest consequence of belonging to the EU. The devaluation of the euro is not only a plague for holidaymakers around the world: it is a signal that policymakers should also pay attention to.
Read more from our columnist Charlemagne on European politics:
The EU’s response to the crisis in Israel exposes its limitations (October 19)
How rugby became the darling of Europe’s chauvinist right (12 October)
Europe is stuck in a need-hate relationship with migrants (4 October)
Also: How Charlemagne’s Column Got Its Name