Sovereign debt bubble thread

[Tamas]

Yep, unexpected, I was short

Isn't this:

-the exact same thing which has been lackluster for the US and failing in Europe for the last almost 3 years, just on a massive scale?
-The Final Shot? What else can they come up with if this won't help?

[Sheilbh]

It's not QE which has been working in the US, lackluster in the UK and not tried in Europe. 

I think the last time the central banks did something like this was after Fukushima.

Hopefully this is the first step in resolving this crisis and it's happened because the EcoFin meeting's made major decisions ahead of the Eurosummit - not just a rejigging of EFSF leverage.  Hopefully.

Edit:  The Observer's economic editor say this confirms we're in a second credit crunch now, the worry is starting to attach to banks as well as sovereigns.  She also said that central banks only coordinate like this in moments of 'extreme crisis'

[alfred russel]

There is a UBS study about a single country exiting the EZ voluntarily I read sometime ago, but I have no idea how good its conclusions are.

IIRC it predicted a loss of something like 20 to 30% GDP in the first year and single digits afterwards for Germany, up to 50% GDP collapse during the first year and a third of that from then on for a weak member.

That doesn't make sense. Countries switch currencies all the time.

I could see a major problem with a single country leaving in terms of a giant legal mess, but a lot of that could be avoided if the euro ceased to exist (perhaps technically replaced with a "european" or some other name).

[alfred russel]

One of their interesting points is that generally curency breakups also involve authoritarian regimes or civil wars.

That strikes me as silly. Multinational currency unions formed by stable democratic countries are rare: the eurozone is the only one I can think of at the moment. Currency unions are often driven by instability (outsourcing monetary policy to a third party to give confidence in the money supply that the government can't), so observing instability at a breakup isn't suprising either.

[Sheilbh]

That doesn't make sense. Countries switch currencies all the time.

What countries do you mean?

I could see a major problem with a single country leaving in terms of a giant legal mess, but a lot of that could be avoided if the euro ceased to exist (perhaps technically replaced with a "european" or some other name).

I think there'd be issues on their debt, almost certainly there'd be widespread defaults of banks.  I don't know how a general collapse would work - beyond not well - but there's no way a country can leave the Euro.  The only treaty provisions are for leaving the EU.  There's no legal way out of the Euro.  So if a country were to leave it would almost certainly have to leave the EU - which means no more common market.  In addition the Commission's said of countries leaving the EU that they would compensate against any currency manipulation - which probably means tariffs.

So if you have a sovereign default, probably banking sector failure, being cut out of your export market and the general economic effects that you exit's caused for your neighbours then I think you'll see serious economic decline.  The UBS assumption for a weak country, say, Greece is devaluation of around 60%, cut of 50% to volume of trade and basically the Argentine model for a banking failure.  They consider these conservative estimates and they exclude the cost civil disorder (there would be riots) and possible national break-up (if we replaced Greece with Belgium, or Spain).

For a strong country domestic defaults not a problem but suddenly the banking sectors got a balance sheet full of New Drachmas, Escudos and Guilders which will be of fluctuating and unpredictable value.  The banks would almost certainly require massive recapitalisation.  The end of the single market would be the end of inter-European exports, in the short term, so it would not be okay for Northern Europe.

I think the reason you have to assume that things would happen legally and chaotically is that given that we're assuming that these governments have so failed that the Euro's collapsing, it seems ambitious to see them somehow creating a structure that allows the EU to remain more or less intact, or to get the necessary treaty changes for Euro-members to leave.

I've heard lots of ingenious getarounds by Eurosceptics of how Greece could leave the Euro while remaining in the EU, none of them seem that plausible.

That strikes me as silly. Multinational currency unions formed by stable democratic countries are rare: the eurozone is the only one I can think of at the moment. Currency unions are often driven by instability (outsourcing monetary policy to a third party to give confidence in the money supply that the government can't), so observing instability at a breakup isn't suprising either.

There's no comparison of stable democratic countries.  The examples they've got are more or less helpful but I think this is fair:

With this degree of social dislocation, the historical parallels are unappealing. Past instances of monetary union break-ups have tended to produce one of two results. Either there was a more authoritarian government response to contain or repress the social disorder (a scenario that tended to require a change from democratic to authoritarian or military government), or alternatively, the social disorder worked with existing fault lines in society to divide the country, spilling over into civil war. These are not inevitable conclusions, but indicate that monetary union break-up is not something that can be treated as a casual issue of exchange rate policy.

Even with a paucity of case studies, what evidence we have does lend credence to the political cost argument. Clearly, not all parts of a fracturing monetary union necessarily collapse into chaos. The point is not that everyone suffers, butthat some part of the former monetary union is highly likely to suffer.

But the truth is Spain, Portugal and Greece were ruled by authoritarian regimes about 30-40 years ago.  Many European countries have suffered from domestic terrorism or violent separatist movements.  I don't think it's possible to rule out violence and authoritarianism rising in the sort of economic context that'd exist if the Euro failed.

[alfred russel]

Sheilbh, look at Latin America, there are periodic currency shifts there, usually after a bout of really bad inflation.

You are making the situation worse than it needs to be. Just because there isn't a mechanism to leave the eurozone doesn't mean the common market will fail if someone needs to leave. A mechanism will simply need to be created.

As for bank failures, I don't see why there would need to be bank failures because of a currency change. I would think that most of the bank liabilities would be in the new euro currencies (probably devalued), and as for dollar liabilities, the euro even with its recent collapse is still stronger vs. the dollar than it was recently including when it first opened. Any prudent risk management would contemplate potential gains for the dollar from where it is now.

As for authoritarian regimes, despite the recent past, I think democracy is quite durable in Greece, Spain, and Portugal.

[DGuller]

What would be the mechanics of some country leaving the Euro?  Surely it's not as simple as that country's central bank just printing some pieces of paper and offering to give that in exchange for a Euro?

[Sheilbh]

Most of UBS's modelling for weak countries is based on Latin America - especially Argentine and Uruguayan currency collapses.

Your assuming a new Euro.  That's only one of the potential options.

You are making the situation worse than it needs to be. Just because there isn't a mechanism to leave the eurozone doesn't mean the common market will fail if someone needs to leave. A mechanism will simply need to be created.

There's simply no mechanism in the treaties.  The treaties can't be amended without the agreement of all 27 countries according to their domestic arrangements - including an Irish referendum.  I get the idea that we'll simply create a mechanism to sort this out but I can't think of an example of the EU ever doing anything like that.  It would be like the US creating an extra-constitutional short-term arrangement.

Obviously you're right that if the Eurozone fails then it'll just fail.   But I think if we've reached that point then it won't be happening in an orderly enough way to maintain the common market.

On the banks weaker countries will either default on domestic debt, pay it in Euros - difficult given the potential trade problems - or force convert it into a new currency.  The government would probably force conversions at a set value - I don't know why they'd only do that to Euro assets either.  That'll be significantly devalued which would damage the banks and the government would need to prevent runs on them and impose very strict capital controls.

For a stronger country it's dealing with the balance sheet of the weaker countries given currency fluctuations - basically the same problem the UK and (probably) the US would have to deal with.  But more because Eurobanks are more exposed.

My general point, as I said earlier, is I think this is like a WW1 situation.  We're rationally stepping towards a state that will reverse the progress of decades.  We can see the crisis coming and ways of getting out of it but are continuing anyway.  Generally I think democracy's durable, but I don't think we're doomed to a better tomorrow and I think faced with the sort of economic turmoil that could arise we shouldn't be too sanguine about it.  Even the recent examples of countries that have gone through something similar - though democracy had a weaker tradition in those countries - are Russia and Argentina.  They're pretty ambiguous.

[alfred russel]

What would be the mechanics of some country leaving the Euro?  Surely it's not as simple as that country's central bank just printing some pieces of paper and offering to give that in exchange for a Euro?

There isn't a mechanism, but it would be a lot more complicated if the euro continued to exist. Otherwise, the governments would need to establish a new currency and exchange rate to euro, and declare debts public and private convert at that rate. There might need to be restrictions about moving currency across borders for a time. There would also need to be some understanding of how multinational contracts are interpreted, which would obviously be difficult considering the common market. It would be a mess.

[MadImmortalMan]

This action makes me wonder if a big eurobank came close to failing last night.

[Sheilbh]

What would be the mechanics of some country leaving the Euro?  Surely it's not as simple as that country's central bank just printing some pieces of paper and offering to give that in exchange for a Euro?

Legally there's no way for a country to leave the Euro.  When the treaties were being updated for the Euro it was decided not to include a withdrawal mechanism.  The theory was that it would show a lack of commitment and that by creating a mechanism to leave you'd make leaving more likely.  UBS suggest, I think plausibly, that it was thought that if you don't have a mechanism you make leaving so painful that no-one will ever do it.

Lisbon allows for a member state to leave the EU - but from what I understand there's no mechanism described and it's a bit like membership it's negotiated on an individual basis.

[Iormlund]

You are making the situation worse than it needs to be. Just because there isn't a mechanism to leave the eurozone doesn't mean the common market will fail if someone needs to leave. A mechanism will simply need to be created.

Creating an orderly exit mechanism would be much harder and slower to do than actually saving the Euro. If we get there chances are it will be pretty much chaos simply because it derives from gross political failure in the first place.

[Sheilbh]

This action makes me wonder if a big eurobank came close to failing last night.

This morning the Italian government asked the Italian Central Bank to extend overnight lending facilities to Italian banks - which was noted as being a bit strange as that's something the ECB do.  I don't know what that means but I've read that it's possibly due to a funding problems?

[alfred russel]

Most of UBS's modelling for weak countries is based on Latin America - especially Argentine and Uruguayan currency collapses.

Your assuming a new Euro.  That's only one of the potential options.

You are making the situation worse than it needs to be. Just because there isn't a mechanism to leave the eurozone doesn't mean the common market will fail if someone needs to leave. A mechanism will simply need to be created.

There's simply no mechanism in the treaties.  The treaties can't be amended without the agreement of all 27 countries according to their domestic arrangements - including an Irish referendum.  I get the idea that we'll simply create a mechanism to sort this out but I can't think of an example of the EU ever doing anything like that.  It would be like the US creating an extra-constitutional short-term arrangement.

Obviously you're right that if the Eurozone fails then it'll just fail.   But I think if we've reached that point then it won't be happening in an orderly enough way to maintain the common market.

On the banks weaker countries will either default on domestic debt, pay it in Euros - difficult given the potential trade problems - or force convert it into a new currency.  The government would probably force conversions at a set value - I don't know why they'd only do that to Euro assets either.  That'll be significantly devalued which would damage the banks and the government would need to prevent runs on them and impose very strict capital controls.

For a stronger country it's dealing with the balance sheet of the weaker countries given currency fluctuations - basically the same problem the UK and (probably) the US would have to deal with.  But more because Eurobanks are more exposed.

My general point, as I said earlier, is I think this is like a WW1 situation.  We're rationally stepping towards a state that will reverse the progress of decades.  We can see the crisis coming and ways of getting out of it but are continuing anyway.  Generally I think democracy's durable, but I don't think we're doomed to a better tomorrow and I think faced with the sort of economic turmoil that could arise we shouldn't be too sanguine about it.  Even the recent examples of countries that have gone through something similar - though democracy had a weaker tradition in those countries - are Russia and Argentina.  They're pretty ambiguous.

Sheilbh, I don't follow the mechanisms. It seems the steps are:

1. Countries decide to dissolve the eurozone.
2. ???
3. Common market is gone.

The common market is distinct from the eurozone, has members that are not in the eruozone, predates the euro, and has almost universal support. I see no reason to think it is going away.

As for banks failing--they might fail because of insolvency issues. That is distinct from a currency problem. But I don't follow how a currency change will make them fail. Both their assets and liabilities would presumably convert based on the exchange rate dictated by the government. It is true that the new currencies might lose value in some countries that could cause problems with non euro liabilities, but at least with the USD the governments have been extremely fortunate in the past. The euro has gained something like 40% against the USD in the past year--even after its recent struggles. Their risk management should be ready for an event that reverts exchange rates back to where they were during a 10 year period.

[alfred russel]

You are making the situation worse than it needs to be. Just because there isn't a mechanism to leave the eurozone doesn't mean the common market will fail if someone needs to leave. A mechanism will simply need to be created.

Creating an orderly exit mechanism would be much harder and slower to do than actually saving the Euro. If we get there chances are it will be pretty much chaos simply because it derives from gross political failure in the first place.

I completely agree. But I can't believe a 30-50% GDP contraction if it was to happen either.