Maybe this will spur politicians in Germany to take more decisive steps to deal with the eurozone debt crisis: today the spreads on credit default swaps (CDS) – those derivatives that effectively provide insurance against default – rose by 8% today on German government bonds. Anyone who wanted to insure their German bonds against default today had to pay over 100 basis points for the first time ever. That’s the same as it cost to insure French government bonds less than 3 months ago, or Italian government bonds about 6 months ago. This week marks the first time that such insurance costs signifcantly more for German bonds than for those of the UK.
But the principal lesson that I draw from this is not that the risk of Germany defaulting on its debt has risen recently. Is Germany really that much more likely that the US or the UK to default? If we take a deep breath and think clearly about things, I doubt that many people would answer yes to that question.
Rather, I take this as a sign that investors are panicking, and panicking specifically about anything having to do with the eurozone. It may not be rational, but a pervasive and ill-defined fear is gripping the financial markets right now. In the current context, that is what contagion is all about.
There are certainly plenty of things for people to worry about right now, of course: stagnating recoveries in the developed world; political brinksmanship and paralysis in the US; endless indecision in Europe regarding how to help the struggling periphery economies; financial institutions that seem weak, opaque, and untrustworthy; slowing growth in China.
All of these factors are certainly contributing to the deep anxiety that currently grips financial markets. But I think that this is evidence that of all of these, the fear of what will happen in Europe looms largest. Which brings me to my own fear: that time is running out for the eurozone to take steps to get the market’s fear under control and avert catastrophe.