Resolving the Eurocrisis: Department of "Huh?!"

Tyler Cowen:

Is the end near?: There is so much talk about what the Germans should do, but I don’t see the viable options.  With Germany’s own credit status now in doubt…

Why does he say this?

At a current ten-year nominal interest rate of 2.268%, Germany's own credit status is not in doubt. Countries whose credit status is in doubt do not have their ten-year bonds selling at a yield-to-maturity of 2.268%.

What has shifted over the past week is that U.S. ten-year Treasury bonds at a yield of 1.95% are now significantly stronger than German ten-year Treasury bonds at a yield of 2.268%. We can hope that this is because the market sees good news: perhaps it expects the ECB to raise short-term interest rates more and sooner because European growth will be faster than was anticipated (but that is extremely unlikely). This may be bad news: perhaps the market expects the ECB to raise short-term interest rates more and sooner to demonstrate that it is tough. Or perhaps the market fears some future chaos event involving the breakup of the euro will make its German bund holdings illiquid just when it would want to sell them to raise cash. This may simply be a recognition, finally, that there are about to be shifts in eurozone political economy and governance that are likely to give the eurozone a slightly higher inflation rate than the U.S. over the next generation.

We don't know.

But a country whose ten-year bonds carry a market yield of 2.268% is not a country whose credit status is in doubt.

The key, I think, is that in a world in which investors are desperate for safe assets--which is our world--then any sovereign which has the political support to run a persistent primary surplus is credit-worthy either if it is believed to be credit-worthy or if a credit-worthy sovereign is willing to guarantee it. Italy is running a primary surplus right now. Portugal, Spain, and Ireland could run primary surpluses with no change in policy if we had a half-recovery to 2007 business cycle conditions. (Greece could not: Greece needs big policy changes.) Nobody I know is doubting that Germany and France can run primary surpluses if they so choose.

But Tyler does not seem to see any of this:

[Germany with an] eighty percent debt to gdp ratio, massive welfare state, and unfavorable demographics, are they supposed to endorse — going to endorse — ten or fifteen percent price inflation for a few years’ time, all with no guarantee of reforms in the economically weaker countries?…

We don't need ten or fifteen percent price inflation. (Although three or four percent price inflation would make things a lot easier.) And we don't need big reforms in the economically-weaker countries--or, rather, even a half-hearted recovery does more good.