Luther and Dross

When on the campaign trail I was often asked why I thought the euro would only last 10-15 years. I used to say part of the problem was Martin Luther.

It won’t make the headlines much but a very important European story is slowly breaking. It concerns international finance so bear with me.

Interest rate differentials in the government bond market – that is to say how much one country pays on its borrowings compared to another - are so small that they are measured in ‘basis points’ (bp), a bp being one hundredth of one percent.

There has always been a tiny difference between the rates on Eurozone government bonds, based on rarity (or in Italy’s case lack of it). Now, you’d expect it to be pretty near zero: the amount that each government can borrow is controlled, no one is going to let a particular country go bust while it is a member of the Eurozone (surely?) and, after all, we are talking about the same currency, the euro.

Yet the yield on different government bonds in the Eurozone is getting wider and wider. What has happened is that investors bought the slightly higher yielding bonds (Italy, Greece etc: the olive belt) because the risk was the same (they thought none of them will go bust since they will be bailed out by Germany), so you got more interest for the same (near zero) risk. But as following the recent crisis they have run short of cash they have been dumping these bonds, which means the yield or interest paid has to rise in order for them to be tradeable. Italy now has to pay 55bp more than Germany on its borrowed money; that’s over half a percent, a huge difference considering it's the same currency. Greece pays 53bp more, Spain 36bp more.

That means an Italian euro is worth less than a German one. Or rather a Southern, Mediterranean, Catholic Euro is worth less than a Northern, Atlantic, Protestant one. That’s where Martin Luther comes in.

People said I was talking nonsense and the euro could never break up. Here is their answer.