Thursday, April 29, 2010

Economics 29/04/2010: Debt crisis is spreading

Another credit downgrade from S&P, this time for Spain, from AA+ to AA with negative outlook, based on the outlook for years of private sector deleveraging and low growth. Spain, as you can see, is severely in red in terms of debt, ranking 14th in the world. Spain's external liabilities stand at 186.1% or $2.55 trillion (as of 2009 Q3) against estimated 2009 GDP of $1.37 trillion.

The country is actually worse off in terms of debt than Greece which has ranks 16th at debt at 170.5% of GDP or $581.68 billion, with 2009 GDP of $341 billion.

Of course, Ireland is world's number 1 debtor nation with external debt of 1,312% of GDP (IFSC-inclusive) of $2.32 trillion in Q3 2009 against the GDP of $176.9 billion. Of course, part of this debt is IFSC, but then, again, we really do not have a claim on our GDP either, with GNP being a more real measure of our income. So on the net, our debts - the actual Irish economy's debts - are somewhere in the neighborhood of 740%. This is still leagues above the UK - the second most indebted nation in the world - which has the debt to GDP ratio of 'only' 426%!

The S&P also provided estimate for expected recovery rate on Greek bonds, which the agency put at 30-50%. In other words, S&P expects investors in Greek bonds to be paid no more than 30-50 cents on the euro. Yesterday on twitter I suggested that "Greek debt should be renegotiated @ 50cents on the euro - severe default. Portugal's @ 80 cents - mild default, Irish @ 70-75 cents". Looks like someone (S&P) agrees. Before it is too late, before German and other European taxpayers have poured hundreds of billions of euro into the PIIGS black hole of delinquent public finances, Europe should cut losses and force Greece and Portugal to renegotiate their liabilities. If Ireland and Spain were to elect to follow, so be it. Of course, in Irish case, the debt re-negotiations should cover private debts, not public debt.

Just how many billions of euros are EU taxpayers in for for the folly of admitting Greece - a country that spent 90 years of the last 180 (since 1829) in defaults on its debts - into the common currency area? Well, Greek 2-year bonds were traded at yields of 26% yesterday at one point in time. This is pricing that's in excess of pretty much every developing country, save for basket cases which practically cannot issue bonds at all.

IMF's Dominique Strauss Kahn has told Bundestag yesterday that Greek package will be

  • €100-120bn for three years;
  • Which means German taxpayers are on the hook for €67 billion over 3 years, not €25 billion that Germany ‘s economics minister was signing for in the original deal;
  • Ireland's contribution will also have to rise to €4 billion over 3 years, not €500 million we originally were told we will have to contribute;
  • Greece will not be forced to restructure or reschedule debt
  • The loans to Greece will be subordinated to existent bondholders, which means that if in the end Greece does pay 30-50 cents on the euro to the latter, European taxpayers will be lucky to get 10 cents on the euro.
The whole deal is now looking like a massive subsidy for Greece and entails absolutely no protection to European taxpayers.

But internationally, EU news are getting darker and darker by the minute. Last night Bloomberg reported that EU countries are in for estimated €600 billion bill for the fiscal crises that have spread across the block. That's the cost, in the end, of all the tacky policy follies that Brussels endorsed and pushed through over the last 10 years -
  • from the Lisbon Agenda, which was supposed to deliver EU to the position of economic superiority over the US by 2010,
  • to the Social Economy, which was supposed to deliver... well, who knows what...
  • to the Knowledge Economy, which was aiming to turn us all into brains in a Petri Dish
  • to the absolutely outlandish HIPCI and HIPCII agendas wholeheartedly embraced by the EU, which were supposed to deliver debt relief to the world's real basket cases (before Greece and other PIIGS took the spotlight away from them), and the rest of the international white elephants.
The problem, of course, is that €600 billion price tag for fiscal excesses has generated preciously little in returns (despite what folks at Tasc keep telling us about the fiscal stimulus) which means we will have to pay for it out of our long term wealth. The same wealth that has been demolished by the recession and the financial markets collapse!


Unknown said...

These are the type of sums you would expect to see as a consequence of ruined economies from a European regional war.

This is the result of European integration via the political elites without the consent of its peoples and it is the third time in a hundred years Europe is in ruins (each time because of elite fanatics who fight about who rules Europe) although this time there has been no actual war.

Midnight Rocks said...

What's the bottom line here? Ireland has much worse debt than Greece but is more responsbile so Irish bonds are still a reasonable prospect?
Is it a matter of time now before Greece pulls down all of the PIIGS and the Euro with it?

Unknown said...

How plausible is a demerger of the Euro, in your opinion?

- A "EuroMark area" for Germany and the northern bloc. Interest rates can be allowed to increase

- A "PIIGS Euro" area for Ireland and the "club Med" countries. Massive devaluation of the currency, but our debt is also denominated in that currency.
We also keep interest rates low.

While there are implications with regards treaty commitments, I wonder is there anything in the rules about a demerger.

Unknown said...

Without being political on this, the horse has already left the stable in regard to a massive restructuring of how the Euro is treated as a reserve currency and on international markets. Here is how it is likely to play out IMHO....

Greeks get bailed out. Every bond market speculator in the world now knows where the support level is and has predictability, especially in terms of when the bailout will come (and from whom it will come). Therefore, it is just a matter of time until the next target (Portugal or some other smaller Euro country) is put in the cross hairs in this political arrangement (and the Greek bailout is more than just economic and market players know this.)

So let's say that Portugal is next and adds even more certainty to the EU bailout terms and conditions. Once that certainty of bailout is reached, then you will see a move on Spain, Italy or another Club Med Euro country.

The fundamental problem is that once a bigger player gets put in the firing line, there will not be enough money to bail them out as well, creating a whole new level of uncertainty for all types of markets and for countries that hold the Euro as a reserve currency. In other words, we saw an modern version of a bank run 2 years ago and central bankers did not agree. Now we are seeing it with public debt and it is not recognized as a "good ol' fashioned" bank run on the public sector. I only wish I could get 200x leverage on a short position for Irish debt (which hasn't been adequately priced.....yet)

Midnight Rocks said...

Is bond speculation, then, essentially the single currency equivalent of currency speculation?

TrueEconomics said...

Great comment... keep them coming... and a quick reply...

Michael, yes, in the end there will be default. What form it will take and depth it will reach is an open question.

Kobriendublin - all possible, except our external debts are not going to be converted into the 'strong euro' at a rate we set for 'Euro-Med', which means the absolute burden of debt will not be deflated to the full extent, only to the extent of the internal debt held by the banks, net of banks' external funding exposures, which are substantial. In other words, 'Euro-Med' will not alleviate the problem of debt in Ireland. And as a corollary - default is still the preferred (rational) option.

James - true as well. Follow your chain of logic and you can see that if we have a collective Euro-wide default (say a haircut on all debts held by the Euro-area vis-a-vis the rest of the world of some 15-20%) today, we will avoid incurring the double cost of the same default later plus the cost of maintaining current insolvent position until then.

Michael - perfect analogy, debt markets are now effectively a substitute for intra-Eurozone FX speculation. Only much more transparent than FX, as there are no third (and higher dimension) arbitrages. Pure fundamentals and logic!

TrueEconomics said...

Ah, sorry - left out the first line of responses:

Susan, yes, except this time around (in the last hundred years) the UK is not a victor either, with massive debt and deficit and the main parties not even willing to deal with these in their electoral debates. I mean the elephant (debt) in the china shop is running wild, there are no shelves left intact, but the staff (Gordon et al) are standing behind the counter still debating which coffee shop serves better sandwiches...

Unknown said...

I agree with Michael....

The problem is that the UK is higher up the food chain in terms of the economic resources available within the country that can be tapped to service debt (i.e., taxes). The PIIGS have no such room....they are taxed to the max.....

Combined with the relative certainty that you have with a bailout compared to Fx markets....I'll even negotiate down to 100x leverage :) Anyone want to back me?

Unknown said...

Following my logic....the 15% TO 20% haircut that you mention is AFTER any small country high debt nations have had their bond yields inverted and then trashed altogether.....

Whoops...that is every euro zone small country...

laughingbear said...

I just learned that the 600 billion Constantin mentioned is equivalent to 8% of total eurozone GDP.

As we know, these J.P. Morgan estimates have habit. They get bigger with time passing. So 10% of total GDP is more than likely.

The drug addict analogy really seems appropriate, just one more hit Ma, I'll be sober from tomorrow. Right!

Unknown said...

Thanks for your response.

Just to flesh out the demerger hypothesis a bit, surely one of those hypothetical currency zones could continue to use the Euro, in its current incarnation.

Maybe the word "demerger" is a bit misleading.

The PIIGS / Club Med could continue to use the Euro, as we know it. In such a scenario, our external debts could continue to be denominated in Euros.

The ECB can set up the "EuroMark" as the new currency.

Kevin O'Brien