Zurich, Switzerland

“It is preposterous to claim the whole crisis is caused by irrational markets. Debt levels are off the charts.” – Kenneth Rogoff, Harvard University

The above quote was pulled from the Weekend Edition of The Financial Times, which I read while flying to Zurich on Sunday night. And it’s dead-right. The Europeans got here because they spent money like crazy. Now the Piper’s calling.

I’m still not convinced the EUR, in its current form, will survive this crisis. This explains in great part why the Swiss franc is soaring since 2008 vis-à-vis the EUR, as investors scramble for safety. The Swiss, unlike the vast majority of European countries, are actually reducing foreign debt in 2010 while others are piling it on. Switzerland commands a positive trade balance but sports a small budget deficit of 0.4% to GDP.

Swiss Franc Up Despite Low Interest Rates

Despite super low interest rates – Swiss 90-day money pays only 0.17% compared to 0.97% for the EUR – investors are stampeding into the Swissie. The franc is up more than 12% against the EUR in 2010 and has gained more than 20% since 2008.

At the very least, the Germans might keep the single currency but introduce a smaller contingent of hard-money members like the Dutch and, of course, for political reasons and, assuming it can fight-off the bond market vigilantes, France. Austria, Finland, Slovenia, Belgium and Luxembourg will also likely remain in the bloc but everyone else will leave and reintroduce their own paper currencies.

For years, the majority of eurozone countries were amassing huge debt levels but the bond market seemingly didn’t care. That ended in August 2007 with the first credit crisis explosion attacking short-term funding markets in Europe (LIBOR) and then spreading like wildfire by the time Lehman Brothers was set ablaze in September 2008.

While credit markets have indeed calmed and credit spreads have returned to normality, government bond markets are anything but normal since last January.

The credit crisis is now at its most dangerous phase as we shortly close out 2010. It’s dangerous because it’s now at the sovereign level. If governments in Europe can’t complete their regular funding auctions then interest rates must rise to attract capital.

What’s truly worrying at this latest inflection point is how even spreads in Germany are rising while peripheral bond markets are weakening; that’s not a good sign. The markets are growing wary of even Germany’s ability to assume guarantees across the entire eurozone yield curve. German rates have risen over the past month, not declined.

From my end, Switzerland has never been more expensive. The franc is paying a dear price for this safe-haven role; worse, at some point, I assume the Swiss National Bank will have to raise interest rates because real estate speculation is growing wild. That alone will attract even more flows to the CHF.

This marks my first visit to Zurich with the franc commanding a 3% premium against the U.S. dollar. Everything is more expensive these days. And with central banks in the West poised to grow inflation at any price, things are bound to become even more expensive.