In his Financial Times column yesterday, Wolfgang Münchau reminds us that the Eurozone debt overhang problem has not been magically swept away by the collective bailout mechanism put together four months ago.

May’s EU-IMF bailout was never a very convincing affair anyway. Supposedly, the collectively stressed peripheral sovereigns promised they would all pool funds with a very ambivalent and internally conflicted Germany, with the IMF matching the total funds at a ratio of 2:1, to stand behind and “guarantee” the solvency of each European sovereign with a “trillion US dollars”. So Münchau’s view that the crisis was not permanently averted but merely postponed does pass the common sense test.

Münchau is particularly concerned for the near term by rising bond yields in the European periphery, versus the very low 10-year yields on the German Bunds, as the excerpt from his FT column below shows:

While the Europeans are celebrating the end of the financial crisis, something strange is happening in the bond markets. The gap in the yields – the spread – between the 10-year bonds of peripheral eurozone countries and Germany has been growing at an alarming rate. It is now close to the level that prevailed in the days before the European Union decided to set up its bail-out fund in May.

Last Friday, the spreads were 3.4 per cent for Ireland, 9.4 per cent for Greece, 3.4 per cent for Portugal, and 1.7 per cent for Spain. The yield on 10-year German bonds is currently ridiculously low, about 2.3 per cent. The financial markets somehow regard Germany as a paragon of virtue, stability and sound financial management, and are happy to demand virtually no return on 10-year investments. If the bond markets were ever returned to normal, and if the spreads were to persist, peripheral Europe would find itself subject to an intolerable market interest rate burden…..

Spain is probably fine for the time being. Portugal’s combined private and public sector debt adds to well over 200 per cent of gross domestic product. In Ireland, the main problem is the banking sector. The economists Peter Boone and Simon Johnson have done some of the maths and found that the total amount of debt likely to end up with the Irish government amounts to about one-third of GDP. They concluded that with 10-year market rates at current levels – close to 6 per cent – Ireland is effectively insolvent. To correct this Ireland would need to generate spectacular rates of future growth. But do we really believe that the Celtic Tiger trick can be replicated? Was the presence of a global financial bubble not inherent in that model?…

In Greece, the adjustment programme is going well – much better than anyone had hoped. Some of the people directly involved with whom I have spoken are almost euphoric in their praise for the Greek government’s approach to the crisis. I also take the government’s commitments seriously, certainly as regards fiscal adjustment.

I am less optimistic when it comes to structural reforms…

To guarantee the solvency of the eurozone’s periphery would require not a few quarters of solid growth, but an entire decade. I am at a loss to understand how countries still recovering from an enormous asset implosion can generate so much growth.

My comment: from the last paragraph quoted above, we can safely add Münchau’s name to the list of those who expect at best, a slow and difficult recovery following “an enormous asset implosion”. In addition, since the credit-fuelled growth of the last few decades was in fact a Ponzi scheme, we can intuit that the absence of growth is not merely a precursor to extended stagnation, but most likely the prelude to another collapse. Governments and taxpayers in Europe don’t have the means to restart the credit Ponzi scheme using the Paulson – Bernanke – Geithner formula that shut down the crisis in the US, partly because of the size of the European banking system (“too big to save”) and partly because Europe is in fact 27 sovereigns with conflicting interests. There will be fireworks out of this in Europe.