The next crisis will sink the eurozone’s only safe haven

Rock-solid finances. Politically stable. A big trade surplus. And a hard-working, hyper-competitive workforce that keeps on taking a bigger share of world markets. We are, of course, talking about Germany. It is no surprise that every time there is a panic in the markets about the state of the eurozone, which happens every three or four minutes, investors flee to the safety of the German bond market.

Indeed, last month the yield on two-year bonds turned negative, which meant people were actually paying the German government to take the money off their hands.

There is a problem, however. German bonds, known as bunds, are as high-risk as every other asset in the crisis-stricken eurozone. Whatever eventual solution is agreed for the single currency, bunds are going to take a massive hit. Once investors flee the market and wake up to the fact that Germany is as bust as every other country inside the euro, the market is going to collapse. It is the next crisis waiting to happen.

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Admittedly, forecasting trouble ahead for the euro is a bit like predicting that there might be some more rain over the summer. It's not exactly going out on a limb. The single currency increasingly resembles a massive motorway pile-up, with so many crashes occurring simultaneously that it's hard for anyone to keep track of them all. The interesting question is what will be the trigger for a final implosion of the system? It might well be a bund sell-off.

It isn't hard to figure out why investors have been flocking into bunds. Of course, a lot of money has fled the eurozone, but it remains the world's largest single economic block and it is hard for many banks or funds to get out completely. So, fearing default, or just heavy losses, investors have been steadily switching their money from Italian or Spanish bonds into the German market. The yield on a ten-year bond has fallen all the way to 1.5%. It hardly costs the government in Berlin anything to borrow any more. The trouble is, Germany's finances aren't in great shape and could be about to get a whole lot worse.

Much is written about the terrible state of government finances in the peripheral countries and how everyone will have to be bailed out by the Germans. But Germany's debt to GDP ratio isn't that great either. It's currently 82% of GDP, only slightly less than that of France and more than Spain, which has already had to ask for a bail-out for its banks.

It has risen from 59% of GDP back when the euro was launched at the start of the last decade. It has been on a path of escalating debt just as much as any other major eurozone nation. Indeed, the much-maligned Italians have at least managed to stabilise their debt while Germany's keeps on growing.

The books haven't been balanced yet. The government will run a deficit of 1% of GDP this year. Nor is the long-term outlook encouraging. Germany has some of the worst demographics in the developed world. After 2015 its population will start to fall sharply. It will have lots of old people and not many young ones a toxic mix for public finances.

But it's what will happen in the eurozone that is really scary. The Germans insist on fixing the crisis with austerity across the periphery. But that isn't going to work for much longer. The Greeks are up in arms about it, and so now are the Spanish, French and Italians.

Going forward, there are only two possible outcomes for the euro. One is that the debts of the 17 member states are pooled. It might happen through joint eurobonds, or by using the Stability Fund to buy the bonds of the peripheral countries. Either way, that is a terrible outcome for Germany. It suddenly becomes liable for the debts of all the other countries within the eurozone. That is a massive increase in what it owes.

Alternatively, the euro might well break up. But that is terrible for Germany as well. Its currency is massively undervalued within the euro. If a new deutschemark soars in value then Germany's export machine will be hit hard. The country will slump into a deep recession. Worse, it will be stuck with huge debts in its banking system. The government will have no choice but to bail the banks out and take all that debt onto its own books.

Whichever way the crisis finally resolves itself, it is going to be catastrophic for the bund market. It is a lose-lose situation. The markets are slowly waking up to this but only very slowly. Once investors catch on that bunds are about as safe as a speculation on Greek banking futures, things could turn nasty very quickly. There are two reasons why.

First, government bonds are core capital for the banking system. A minor shift in prices doesn't matter very much. But if German bonds started to collapse the way Spanish or Italian ones already have, then the banks would be bust. That would take the eurozone crisis to a whole new level.

Second, bunds are the only safe haven' left in the eurozone. Once you've decided they are too risky, there is nothing left to do but get out of the currency completely. A collapse of the bund market could well prompt wholesale capital flight from the euro area and the single currency simply couldn't survive that.