EU dominos - who's next?

The chart below (from the Bank of England's Charles Bean) shows the 10-year government bond spreads for selected EU nations: Portugal, Ireland, Italy and Spain, as well as France and the UK.



Where is Greece in this 'who's next for disaster' chart? You might ask. Well, Greece is off the chart with its 10 year bond spreads currently attracting interest at somewhere north of 26%, according to Bloomberg.

Off the chart and out of the game. It's debt is unrepayable. The question is if Greece defaults will that have a domino effect? The potential domino effect is twofold:

1. German and French banks are most exposed (see Dexia already), but some debt is held by Spanish, Italian and Portuguese banks. A default or severe 'haircut' (partial write-off) of say 80% would have an impact. These nations would then be faced with a choice: a) let a bank fail; or b) bail-out the bank with more government debt, further worsening the sovereign debt crisis
2. The second domino effect is on the bond markets, which would be spooked by a default and hike interest rates on riskier debtors - in the same way that high street banks have jacked up margins and became more cautious lenderdfollowing the credit crunch, restricting lending to businesses and damaging the economy. This could mean Portugal, Spain, Ireland and Italy paying more for their debt - exacerbating their debt crisis, and potentially sending them into a Greek-style death spiral.

It's worth bearing in mind that if Italy, as the third largest eurozone economy, got in trouble the whole eurozone would be at risk. It currently has 2 trillion euros of debt.

Since the Bank of England produced the above chart, Italy's bond interest rates have risen from around 4% to 6%. If that gets up to Portuguese levels, let alone Greek, then Italy is in serious risk of default. Even a 20 or 30% haircut would be deeply traumatic - crashing banks around the world, with serious domino effects.

That's why the G20 meeting in Cannes is obsessed with this issue: finance capitalism is at risk!