Michael Pettis — The unacceptable behavior of the market

To start off, in mid-June, just a couple of days before the Spanish treasury raised €2.2 billion in an auction – one in which the cost of borrowing surged, with 10-year bonds breaking 7% – France’s new president complained about the unfairness of the financial markets. According to an article two weeks ago the Financial Times,

“It’s not acceptable that Spain, which just got a promise for support, has interest rates around 7 per cent,” Mr Hollande said. “It’s not acceptable that countries that are making efforts, like Italy, to improve their public finances,” were paying high interest rates on their bonds.

It would be useful if policymakers (and not just in France) had an understanding of how markets actually work. Hollande is effectively complaining that markets are reacting not to what policymakers propose they will do but rather to something else, and he believes that this is unfair, even unacceptable.
But clearly it isn’t. Since that “something else” to which the market is responding is the underlying process of balance sheet unraveling, and this is happening no matter what policymakers might say in the G20 meetings or elsewhere, it actually makes a lot of sense that markets overall continue to deteriorate.

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I am not sure what O’Neill means by Europe’s behaving like a “true union”, but if he means Europe’s immediately becoming the United States of Europe overnight, which is certainly not a mind-bogglingly simple policy to implement, then the euro part of the euro crisis will certainly end. What won’t end, however, is the need to write down a staggeringly large amount of bad loans and to cover the banking losses with transfers from the housing sector, nor the rapid slowdown in growth even in countries like Germany....

At this point the only thing that can save the euro is a combination of moves in which the European banks are guaranteed by a credible institution and in which Germany takes steps to stimulate its economy quickly and dramatically. Until Germany is willing to boost domestic spending enough to run a deficit that allows Spain to run a surplus, it is impossible for Spain to repay its debt. This is just basic balance-of-payments arithmetic.

Read it at China Financial Markets
The unacceptable behavior of the market
by Michael Pettis

The post goes on to discuss China and Minsky on balance sheets.