It is finally being recognized that the eurozone made a major policy breakthrough

Yields on short-term peripheral sovereign bonds are plunging, despite the fact that EU leaders appeared to make little progress at their highly-anticipated summit last week.

Pundits continue to expound on the flaws of the eurozone but markets are telling a different tale.

That’s because the European Central Bank may have already introduced roundabout measures that will solve some of Europe’s big problems—it’s making investing in peripheral sovereign debt a huge profit opportunity for banks.

Theoretically, financial institutions will be able coin money by borrowing ultra-cheap from the ECB and buying higher yielding sovereign debt.

Here is the story, and you will recall my earlier post here.  Karl Smith asks how this fits in with the treatment of collateral, and here is also a more skeptical take on the arbitrage.  My view is not that banks will find the arbitrage opportunity overwhelming (that is unclear), rather my view is that public choice mechanisms will operate so that desperate governments commandeer their banks to make this move, whether the banks ideally would wish to or not.  Make no mistake about it, this is doubling down and raising the stakes.  It’s funding debt through more debt.  It’s wrong to say the summit accomplished nothing, or consisted merely of empty, unenforceable pledges of austerity, although it did that too.

At this point you have to be asking whether it is better to simply end the eurozone now, no matter how painful that may be.  Unless of course you are an optimist about Italy reaching two percent growth, or Germany becoming fully cosmopolitan.  As a politician I probably could not bring myself to pull the plug, but as a blogger I wonder if that might not, at this point, be the wiser thing to do.  Current crisis aside, does anyone out there see the euro’s governance structure — even with reforms — as even vaguely workable?

Addendum: Do note also that the ECB has made no strong promise to continue this program, and indeed it is not in a position to make a credible commitment, most of all on the quality of collateral issue.  That means a lot of ups and downs, shifting credibility, and the gains could well collapse quickly.


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