Irish bonds led a slump in debt issued by the euro area's high-deficit nations amid speculation that rescue talks won't damp the region's escalating crisis.

Spanish and Portuguese securities slid on concern more countries will struggle to manage their obligations as borrowing costs surge. Irish Prime Minister Brian Cowen signalled yesterday he would call elections for early 2011, triggering concern any agreement on a bailout may not be upheld. German two-year yields dropped below 1 percent after North and South Korea exchanged fire, pushing investors to seek the safest assets.

"This political uncertainty won't let Ireland enjoy the upcoming benefits of an aid package," said Ioannis Sokos, an interest-rate strategist at BNP Paribas SA in London. "There's clearly a contagion effect from Ireland" for other euro-area nations, he said.

Irish 10-year bonds fell, sending the yield 24 basis points higher to 8.55 percent as of 12:47 p.m. in London. The extra yield investors demand to hold the securities instead of German bunds widened 25 basis points to 569 basis points.

Spanish 10-year bonds dropped a sixth day, with the yield 12 basis points higher at 4.87 percent. Portugal's 10-year yield rose seven basis points to 6.88 percent.

Eoin Treacy's view I posted a link to a Eurostat press release in Comment of the Day on April 22nd which listed government deficits and the debt to GDP ratios for EU countries as of the end of 2009. In the meantime, the Irish deficit was revised sharply upwards because the Commission ruled that bank recapitalizations had to be accounted for as government debt. It is interesting to revisit that document today as arguments rage on whether Ireland and other peripheral nations will be able to pay off the debts they are taking on from their respective banks.

At the end of 2009 Ireland's debt/GDP ratio was in the region of 64%. At the end of 2008 GDP was $220 billion and probably closer to $190billion or lower by the end of 2009. The size of the EU/IMF bailout currently being proposed is in the region of €90 billion which would take total debt to GDP to well in excess of 100%. With such enormous sums being considered I wonder how realistic it is to expect the total burden of debt to be borne by the debtor rather than shared with creditors.

A point I make at The Chart Seminar is that every crowd is tolerant of contradictions until dispersal sets in. The Euro is based on the assumption that one monetary policy would be appropriate for 16 different fiscal policies. The peripheral Eurozone debt crisis highlighted how incorrect that hypothesis is and policy initiatives are currently being put in place to improve fiscal cohesion. However, this does not heal the very real debt problems that were allowed to develop over the last decade.

Without currency union, countries such as Ireland, Portugal, Greece, Spain or Italy would have recourse to a significantly weaker currency to help defuse their debt problems and improve competitiveness. One look at these legacy charts of the Punt, Drachma, Escudo, Peseta and Lira shows how inappropriate the Euro at today's value is for these countries. (Please note Punts were quoted IEP/USD rather than the other way around). On the other hand, today's Euro is probably considered by many at the Bundesbank to be too weak to contain nascent inflationary pressures in Germany. This is another contradiction that will eventually have to be dealt with.

German, French and UK banks are most exposed to bank and sovereign debt in the periphery. Greek and Portuguese sovereign debt, Irish banks and Spanish banks and Cajas pose a serious threat to already weakened financials in the rest of Europe. It is for this reason that governments have been forced to absorb private sector debts. The core Eurozone quite rightly expects those who borrowed to pay their debts. Bailouts on the periphery are seen as preferable to defaults and bailouts in the core. It remains to be seen whether voters in high deficit countries will be willing to accept the amount of economic hardship required to bring debt levels back into line with Eurozone requirements.

Short-term, risks are skewed towards further expansion of peripheral yields. Over the medium-term, the big question is about competitiveness. The last decade saw countries such as Ireland, Greece, Spain and Portugal substitute a focus on exports and balanced budgets for spending and higher wages and inflation. The contraction in labour and other costs, if allowed to run its course, will improve competitiveness and set the stage for a medium-term recovery. Longer-term, it is to be hoped that voters display the fortitude and integrity necessary to make sure politicians with a focus on fiscal responsibility are put in power, lest the boom to bust pattern of development prove interminable.