Europe and China: Is this Deja Vu All Over Again?

The autumn of 2010 is in some ways a replay of what we saw last spring. Is what we saw then a guide to what’s going to happen next?

Last spring the yield on 10-year Greek sovereign debt spiked up 600 basis points as concerns rose about the country’s ability and willingness to meet future interest payments. After a significant bailout from other European countries and the IMF, yields settled back down. They crept back up this summer, fell in September and early October, and are now back up almost to the peaks reached at the height of the crisis.

The concern last spring was that problems in Greece could spill over into other European countries such as Ireland and Portugal. Their long-term sovereign debt yields were up 100 and 200 basis points on the Greece concerns last spring, but have shot up much more than that over the last month.

As Paul Krugman notes, the really scary thing is that Spain and Italy, which were relatively untouched by the fears last spring, have also seen dramatic moves up in their apparent risk premia.

Charts: Bloomberg

Thus we’re seeing last spring’s sovereign debt concerns being replayed in slower motion but on a broader scale than the first time around. There’s another interesting parallel with last spring’s concerns. The developments in Europe have coincided with efforts by China to raise interest rates and tighten credit. And just as we saw last spring, the decline in China’s stock market has been as big as that for European equities.

Blue: SSE Shanghai Stock Exchange composite stock price index. Red: IEV S&P Europe 350 stock price index. Source: Google Finance

If this is deja vu all over again, what might we expect next? What happened last spring was a flight to the dollar as a seemingly safe refuge. And there’s been some appreciation of the dollar with the latest events as well, with more to come if history repeats itself.

Exchange rate in euros per dollar. Source: Yahoo Finance

But this is a slower-moving and broader wave than the first one. And tsunamis pack much more power than a simple crashing breaker.

Europe and China: is this deja vu all over again?

About James D. Hamilton 244 Articles

James D. Hamilton is Professor of Economics at the University of California, San Diego.

Visit: Econbrowser

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