John Paulson, the President of hedge fund Paulson & Co, is now shorting German bunds. Paulson became famous for his shorts relating to the subprime mortgage crisis in 2008, but has struggled in recent years, with big bets on financials and what one might call “junk stocks.” Yet, this short bet on the German bunds has a chance to succeed in a big way; the only real question to me is one of timing.
Price distortions and trade imbalances created by the Euro are the real problem in Europe. It’s no coincidence that nations like Poland, Norway, and the Czech Republic have been amongst Europe’s best performing economies over the past decade. While these three economies are at different stages of progression, the one commonality is that none are pegged to the Euro.
By making the German currency artificially weak, the Euro has created a situation where Germany has perpetually loose monetary policy and lower-priced exports. Conversely, by making the Spanish and Portuguese currencies artificially strong, those two nations have perpetually strong monetary policies and crippled export industries.
These distortions coalesce to create a net destruction of wealth in the eurozone. The situation is inherently unstable and can only be solved by either fiscal integration or dissolution of the eurozone. Regardless of the solution, the result for German bunds should be the same: a fall in price.
To understand why German bunds must fall, it’s important to understand why the prices are so high (and the yields so low) to begin with. The Euro’s trade distortions have helped create a mirage of prosperity around Germany, which has led many to view German bunds as a “safe haven” in the same sense as US Treasuries. However, there are major differences between the US Dollar and the Euro.