The defaults of Greece, Ireland and Portugal show there is no such thing as a risk-free asset.
Of course, there was no such thing as a risk-free asset before those defaults either. The false comfort that developed economies could be relied on to stay out of economic trouble and thus repay their debts created the conditions for the European debt crisis to happen.
Investors have woken up, as European sovereign bond yields show.
The fear that big economies such as Italy and Spain could go bust is an emerging source of potential instability in global financial markets. That's because shrinking supply and rising demand makes investors doing unpredictable things. Given the state of European politics and finances, there seems little reason to hope investors will change their opinion about European debt any time soon.
But there is another way. Princeton University's Christopher Sims, a Nobel laureate in economics, said on a panel on the sidelines of the International Monetary Fund meetings in Washington on the weekend that there is more to the higher bond yields in Europe than a lack of confidence in governments.
Also in the price is recognition that governments such as Spain and Italy can't print their own money. The United States and Japan also have horrendous budget problems, but investors recognize that Washington and Tokyo can print dollars and yen, respectively, if they want to. Excessive money creation is problematic, of course, but in the short term it significantly reduces the risk that any country with a printing press will default on its obligations.
There is "no short-term risk to bond holders" if a country can "print what it promises to pay," Prof. Sims said.
This is an argument for Germany and other countries to drop their resistance to euro bonds. Rising borrowing costs across Europe are hurting governments' ability to generate growth and maintain social programs. They also put credit out of reach of some households and businesses.
Euro bonds would be considered a safe asset, and investors would accept lower yields to own them. This would benefit the entire euro zone.
The only way to return to normalcy in European debt markets is to deliver on euro bonds, Prof. Sims said – and not over the long term, but "soon."