European Feedback Cycle of Doom (part due)
(or "Fantastic fears of inflation were expressed. That was to cry, Fire, Fire in Noah's Flood.")


As the rates of Italian ten year bonds pass 7 percent (after a brief pause at 6.66 (what's up?!?! Just stopped to say hi)) Krugman comments:

I still find it hard to believe that the euro will fail; but it seems equally hard to believe that Europe will do what’s needed to avoid that failure. Irresistible force, meet immovable object — and watch the explosion.

DeLong provides an explanation for the blissfully ignorant:

Italy's debt is sustainable if Italy must pay 4%/year in interest to borrow. If Italy must pay 7%/year in interest its debt is not sustainable: the Italian government must then com cup[sic] with an extra €60bn/year to appease the bondholders--that's an extra 4.3% of GDP in taxes.

And if nothing has done to convince bondholders that extra 4.3% of GDP tax increase dedicated to compensating them for default risk is coming, next year what will be needed will be not 4.3% of GDP but 8.6% of GDP.

Burlesque-oni looks to be on his way out as the bond vigilantes (and the German cult of 2 percent inflation) accomplish what numerous sex scandals could not.

John Quiggin* on the European Central Bank, crisis enabler.

But Mr. Draghi needs to do even more if he is to avoid becoming the first central banker in recent history to preside over the collapse of the currency he was appointed to manage.

The crucial step is to announce that the central bank will stand behind the sovereign debt of euro zone members, if necessary at the expense of the 2 percent inflation target. This would give governments the financial resources they needed to recapitalize banks. Since the crisis is largely one of confidence, it is likely that bond markets would stabilize without the need for large-scale bond purchases, once there was a credible commitment to intervene where necessary.

In his first news conference as the central bank’s president, Mr. Draghi gave mixed signals. Rhetorically, he emphasized consistency with the failed policies of the past. But in practical terms, he announced a cut in interest rates, effectively admitting that the last increase, only five months ago, was a mistake.

The opportunity for him to take a new path will not last long. If current policies are pursued, the European Central Bank will end up by destroying the euro in order to save it from (largely hypothetical) inflation.

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*author of the infamous 6-6-6 plan.