We all know much more about sovereign debt solvency than we did a couple of years ago. We now understand some of the dynamics of insuring sovereign debt, we know a lot more about the debt loads of numerous countries than we maybe ever even thought about previously. The most recent concern would seem to be Greece and of course the rest of the PIGS or PIIGS as some prefer to think of, that second I being Italy. The folks at Zero Hedge would also point us to the STUUPID countries as well.
One line of thinking that I have read and heard repeatedly, getting back to Greece, is that it is too small to really threaten the EU. At two point whatever of the EU economy it is hard to argue against that point but it is the incorrect point in my opinion.
People are worried that Greece will default on its debt. It has a large budget deficit around 13% and public sector debt is around 115% of GDP (eyeballing Bill Gross's Ring of Fire Chart). Ken Rogoff has taught us all that 90% is a Mendoza line of sorts (as in Mario Mendoza). Either Greece will default or not and if not it will be because the EU bailed it out or not (please note the phrasing of that last sentence is such that I make no attempt to guess the outcome).
The thing is not the outcome for Greece the thing is what comes next. If Greece is bailed out somehow because it did not have the will to do what it had to then where does that leave Ireland which appears to be taking the difficult steps to heal on its own? If they bail out Greece, what will they do if Portugal and Spain end up needing a bailout? It is possible for members of the EU to default because they cannot print their own currency.
Sweden and Austria had some real trouble for their loan exposure to other countries (talking mostly small countries in Eastern Europe)--a contagion of sorts. Things on the ground in Sweden were never terrible but Latvia almost became a huge problem. So in thinking about Greece we should be thinking not just about what happens there but what could happen elsewhere as a result.
Think about how the financial crisis unfolded in the US. It was one thing after another and then another. Contagion happens and while a default in Greece (a low probability IMO) might not have a domino effect, assuming there would be no domino effect is either an incomplete study or an overly optimistic assessment.
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6 comments:
No, Greece is not too small - "we're all Greeks now" - In and of itself a Greek bankruptcy or bond default should -in theory- not affect the Euro as such very much, Greece being maybe 3% of the total. However, just as a Californian bankruptcy would reflect badly on the "state of the Union" as a whole so would the default of on EU country, coupled with the rising interest rates and thus further destabilisation of the remaining over-leveraged member states, make investors wonder when sovereign default across the board is likely. Thus they wouldn't commit themseves to bonds of longer maturity and that's the beginning of the end.
From an investing standpoint, I think the thing is the psychological impact of a default (let alone a contagion.) Heck, markets are already struggling at just the hint of a default. Where are investors fleeing, to gold for safety? Nope, to that non-reserve currency, the $US.
Sovereign debt is a problem, but heck just the debt levels of consumers most places is a problem.
This will be papered over this time and the "expansion" will continue. This is a slow motion train wreck and these problems will be revisited in the future.
Interesting that China is buyig USO and GLD.
Looks like the Germans, like it or not, will end up with some pretty greasy wurst.
BillM
Roger,
I agree that Greece's default chances are low right now, but over the longer term it is a mathematical certainty if habits are not changed.
The bigger point here that is rarely mentioned in the mainstream press is wealth is not created through debt. We have too much debt at all levels: government, consumer and corporate (although some corporate balance sheets are very strong, but junk debt has exploded).
If we see rates rise even a couple percentage points from where they are now, debt repayment will be too high for most borrowers. Default will be the best option.
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