Up to January, the European Central Bank lent European private banks about €500 billion at 1% interest.
Last night the banks gave €18.5 billion of that to the Italian and Spanish governments at about 2.79% and 3.75% interest respectively. Presumably the rest has gone into US bonds at 2%.

Nice work if you can get it.

The mood on financial markets has been lifted this morning by the success of the bond auctions by Italy and Spain, which is to say the euro went up a cent and sharemarkets didn’t fall, but banks are merely playing a carry game — recirculating ECB money into government bonds for a lazy profit margin.

Meanwhile, in Greece the banks and hedge funds are trying to prevent their losses from blowing out above 50% as the IMF and ECB refuse to accept any losses at all (so far).

The Greek stand-off is almost comical, with the latest reports noting that Greece, bankrupt as it is, holds all the cards. The IMF seems to think it’s an argument between Greece and its creditors, but in fact the country itself is merely a spectator.

Greek debt is trading at 20 cents to the euro so if the lenders get away with a 60% loss they’re doing OK.

Time is running out for a final deal on Greek debt but eventually they will have to at least pretend to agree on something. Unlike Italy and Spain, Greece has no hope of refinancing any debt through the markets so its only hope of achieving a sustainable balance sheet is through big writedowns from creditors — including the IMF and ECB.

Portugal, meanwhile, still has its debt selling at yields of about 13% and will have to come to the market soon for money. It can’t pay that sort of interest, of course, so there may have to be writedowns there as well.

The joke of it all is that amid all this the US bond yield is sitting at 1.93%. The worse its fiscal political situation looks, the happier bond investors seem to be. UK and German bond yields are also very low.

Since US debt was downgraded by Standard & Poor’s last August, the US 10-year bond yield has actually fallen from close to 3% to below 2%. So much for S&P’s authority.

America’s total debt has hit the ceiling again and there is no sign of any political will in an election year to tackle it — apart from Republican candidate Ron Paul, who did pretty well in New Hampshire.

US Treasury recently put out a document called “A Citizens Guide to the Fiscal Year 2011 Financial Report of the US Government”, which revealed that, just to stabilise the ratio of debt to GDP at the current record high level, Treasury would have to achieve a primary surplus of 1.1% GDP every year for the next 75 years.

Current US primary deficits, remember, are about 10% of GDP, and that doesn’t include interest, admittedly low at the moment.

But of course investors aren’t watching fiscal balances, either in the US or Europe — they’re keeping an eye on the central banks and the rivers of cash that are flowing out of them at 1% interest.

At some point inflation will start rising and the river will dry up, marking the start of a new structural bear market in bonds. But there is no sign of that yet.

All attention is focused on the present, and the hour-by-hour live blogs on the European debt crisis. What is Mario Draghi saying? How are the Greek negotiations going? Will Merkozy fix it?

Pretty soon bond investors will have to lift their heads and look ahead a year or two, maybe three, and they won’t like what they see.

*This article first appeared on Business Spectator