Sovereign debt bubble thread

[Tamas]

Yes well, we can't really expect politicans to think ahead and take unpopular measures when it is not absolutely necessary. It is against their interests.

[Admiral Yi]

Uh, oh!

It seems Rajoy has finally grown a pair. He has presented a budget with 5.8% deficit, well over the 4.4% our northern friends demanded. Any bet on what will be the response?

Grown a pair?  Greek politicians must be the manliest in the world then.

Somehow I don't think this is the reaction the ECB was hoping for when it flooded the Eurozone with cheap bank credit.

[Iormlund]

Grown a pair?  Greek politicians must be the manliest in the world then.

The Greeks don't bother with this kind of thing. They simply pass the budget they were asked to knowing perfectly well they'll miss it.

Somehow I don't think this is the reaction the ECB was hoping for when it flooded the Eurozone with cheap bank credit.

Even the people at the ECB must now realize austerity is a gigantic failure. I'll concede that are quite a few morons on that board, but Draghi at least seems intelligent enough.

[Admiral Yi]

Even the people at the ECB must now realize austerity is a gigantic failure. I'll concede that are quite a few morons on that board, but Draghi at least seems intelligent enough.

I get the impression you don't understand what the objective of austerity is.  It's not to increase growth or decrease unemployment.  It's to decrease deficits to a level that the bond markets won't get freaked out by.

[Iormlund]

Not really. Spain has very low debt compared to most developed economies. A few more points wouldn't make a difference.

Investors are scared shitless precisely because there's no light at the end of the tunnel. Austerity doesn't make a difference to the bond markets. The only thing keeping us from dragging all of you with us is the rabbit Draghi pulled out of his hat in December.

[Sheilbh]

I get the impression you don't understand what the objective of austerity is.  It's not to increase growth or decrease unemployment.  It's to decrease deficits to a level that the bond markets won't get freaked out by.

But the problem in Spain and Italy isn't purely one of debt or deficit.  The Spanish have low debt and the Italians are running a primary surplus.  The problem is the lack of structural reform over the last decade and the worries about potential growth.  But you're right austerity and structural reforms don't necessarily work well together.  That's Europe's dilemma and the problem many people have with the proposed 'solution'.

And Iorm's right.  Monti's had an effect in Italy but generally the biggest the biggest impact on the bond market has been the hints at expansionary ECB policy and cheap loans to banks.  But even now when Europe's facing a serious possibly existential recession the ECB's measures are far short of what the Fed or the BofE have done in the past few years.

[Admiral Yi]

Not really. Spain has very low debt compared to most developed economies. A few more points wouldn't make a difference.

Investors are scared shitless precisely because there's no light at the end of the tunnel. Austerity doesn't make a difference to the bond markets. The only thing keeping us from dragging all of you with us is the rabbit Draghi pulled out of his hat in December.

If bond markets are indifferent to austerity, why did the Greek spread jump when it was announced that their debt was signficantly higher than previously stated?

I've said before that looking solely at debt/GDP Spain is in fact the odd man out.  But look at the debt/GDP ratios of the rest of the PIIGS and compare them to the northern Europeans.  It's not some Protestant global conspiracy that's driving bond prices.

[Iormlund]

You can't just compare one country to another. While the underlying problem is the same, low competitiveness and a flood of cheap credit, how it manifested itself varied greately.

While Greek governments threw away money and cooked their books, Ireland and Spain paid back debt. Italy still has a strong manufacturing sector and primary surplus, Greece and Spain have primary deficits and shrinking industries. Ireland and Spain are coming down from housing bubbles and private indebtedness is very high. And so on.

[Tamas]

I understand that debt may not be the most immediate problem for Spain and Italy but if they don't decrease their reliance on loans (dunno Spain but I do remember that Italy was running it's budget on deficit), it WILL eventually become a problem as they will get loans on ridicoulous terms. Like it was happening for Italy for a while.

[Iormlund]

I don't think you understand. I'm not saying debt isn't a problem. I'm saying the problem is not the amount, but that investors think we aren not in a position to pay it back. That's a very different thing and requires a different approach.

[Sheilbh]

I understand that debt may not be the most immediate problem for Spain and Italy but if they don't decrease their reliance on loans (dunno Spain but I do remember that Italy was running it's budget on deficit), it WILL eventually become a problem as they will get loans on ridicoulous terms. Like it was happening for Italy for a while.

No-one's disputing that debt's a problem.  But I think the PIIGS acronym has made this one problem with a single solution when that's not really the case. 

Debt is a huge problem in Italy.  It's got a debt of 120% of GDP.  Its running a primary surplus, so without the cost of servicing the debt they're fine.  The cost of servicing their debt means they need to make cuts but they've not got an enormous deficit, I think it's around 4% of GDP at the minute and falling.  I actually think the current Italian deficit and the projected Italian deficit is one of the smallest in the Eurozone (average deficit of around 6%) and is roughly the same as Germany's.  The projections of the Italian deficit are smaller than, say, in the Netherlands.

The problem the Italians have had is that over the last decade their economic growth has been slower than every country except for Haiti.  They averaged annual growth of 0.5% in the 2000s.  They've not had any of the necessary structural reforms that would help encourage growth and instead have been hindered by a government that was primarily concerned with limiting the PM's criminal liability.  Ironically the period of post-war Italian history when they've had a strong stable government has turned out to be the worst for them. 

On the upside Italian debt and deficit is still smaller than it was when Berlusconi's first government collapsed and he was replaced by a technocratic Prime Minister...

But given the size and importance of Italy I think that right now Mario Monti's the most important politician in Europe.  If his deficit and debt reduction and structural reforms don't work then the Euro's in real trouble.  Which is why I think he needs all the support he can get.  Unfortunately that doesn't seem forthcoming.  I think Italy needs credible deficit reduction, structural reforms plus support on their debt by the Eurozone to reduce the cost of the debt if possible and support by the EU as a whole to increase growth.  Monti's suggested some serious EU liberalisation (backed by the UK and Northern European liberals and Spain) apparently the French are dead opposed, especially in an election year, and the Germans don't want to fight the French over liberalisation as well as austerity - at least that's what the British press have been told.

But it's worth remembering that the deal on Greece is that the private sector take a haircut, which they won't be able to claim the insurance on. The Greek government continues to cut at an extreme rate and pass difficult and unpopular reforms.  The Greeks deal with 8 more years of austerity.  The Eurozone will probably have to bail them out again once or twice.  At the end of all that Greece will have government debt roughly approaching the level of Italy.  That's assuming the Troika's rather optimistic growth forecasts are accurate.  The Greek economy shrank by 6.8% last year, 7% (annualised) in the last quarter.  The Troika's downside assumptions are that they'll get that down next year and the economy will only shrink by 1% in 2013.  Even that seems optimistic, but, if Greece follows the downside assumptions then they reduce their debt to 160% of GDP.

[Admiral Yi]

That's one thing that baffles me--why in the world would a Greek bond holder voluntarily take a haircut when the alternative is to force a default and collect the CDS?

[Iormlund]

Because he will be under pressure from governments and central banks to do so. Because he might also be in the business of selling CDS. Or because he holds substantial debt from other PIIGS and doesn't want to rock the boat and lose it all for what is relatively small potatoes.

[Sheilbh]

I think 90% of Greek private sector debt is held by Greek creditors.  Given that the government's retroactively legislated collective action clauses into all of those bonds they presumably only need a certain percentage to approve and then they all do.  From what I can tell the EU negotiations were pretty hard with the IIF, I think there's a lot of leaning on them by the Eurozone but I think some bondholders are going to participate in the complex ECB-national central bank bond sharing thing.

The real worry is if bondholders start to worry about whether there's any point in insuring their Eurozone sovereign bonds.  If there's not, then that'll be reflected in the cost.

[Sheilbh]

It looks like the Dutch deficit situation's a bit more serious than I thought.  Apparently the government could collapse if negotiations on new budget cuts fail.  The problem is it's a minority coalition government that depends on Geert Wilders for a majority.  He's said that they're unlikely to agree if they discuss 'just finance'.  The problem for the government is that Wilders is okay with there being new elections, while neither of the governing parties are, in fact the minority party's in a leadership election.  So Wilders has a lot of influence.

If the Dutch fall it could be a really interesting year.  From what I've read the Netherlands isn't like Germany, with the main opposition party being even more supportive of the bailouts.  There's a lot of opposition on the right and the left which would make their election interesting.  But we'd have elections in the Netherlands and Greece who are the achetypal creditor and debtor nations.  The French elections and Irish referendum may not even be the most important.