Last updated: November 17, 2010 5:26 pm


A financial crisis is generally caused by the collision of dreams and reality. Usually, it is investors who do the dreaming and a shortage of cash, often induced by central bankers, which causes the crash. In the current eurozone mess, it is the other way around.

The dreamers are the central bankers, bureaucrats and politicians (not just in Europe) who believe bad debts do not need to be written down. The delegation heading for Dublin to cut a bank deal with a reluctant government is not going to give a “put up or shut up” order to banks short of funding. It will offer EU funding to keep the dream of solvency alive.

The troubled debtors’ dream could come true, with the correct mix of modest inflation, rapid growth and fiscal tightening. But there are already signs of trouble. The Portuguese unemployment rate is rising and an embarrassingly realistic politician, the Austrian finance minister, just pointed out that Greece already seems to be falling behind on its fiscal promises.

Investors have woken up. In Ireland, over the past month, the yield on 3-year government debt increased from 4.1 to 6.9 per cent (which prices in a 17 per cent writedown before 2013). No new issues are expected until well into 2011. But higher margin requirements make trading more expensive; speculators have been taking short positions; and many holders have decided to hedge or sell. On the other side, cash-rich local buyers and foreign interest are both scarce.

In pure dream-logic, the EU, with the help of the like-minded European Central Bank, could borrow or create enough money to compensate for the investors’ retreat. But in reality, across the eurozone, the political will to subsidise improvident borrowers is wearing thin. A Dublin rescue will not be enough to turn investors into dreamers.

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