Sovereign debt bubble thread

[The Larch]

IIRC, in the last couple of expansion rounds (EU 25 and EU 27) the requiriment to eventually join the Euro was included in all accesion treaties with the new members.

It was already included in the EU15 expansion, but Sweden doesn't give a fuck.

Don't they have some kind of peg? Or is that Denmark?

[Zanza]

Denmark has a +- 2.25% peg to the Euro. It had a similar peg to the Deutsche Mark before.

[Zanza]

Can the chart on the second page of this be real?
http://www.scribd.com/doc/74335711/Hayman-Nov2011

Holy fuck if it is.

What does it say? It's just gibberish on my work computer.

[The Larch]

Can the chart on the second page of this be real?
http://www.scribd.com/doc/74335711/Hayman-Nov2011

Holy fuck if it is.

What does it say? It's just gibberish on my work computer.

That currently global debt is the highest in history for a peacetime period, and has grown yearly by 11% since 2002, while global GDP has only grown 4%.

[Admiral Yi]

That currently global debt is the highest in history for a peacetime period, and has grown yearly by 11% since 2002, while global GDP has only grown 4%.

Just sovereign debt, or all kinds of debt?

[The Larch]

That currently global debt is the highest in history for a peacetime period, and has grown yearly by 11% since 2002, while global GDP has only grown 4%.

Just sovereign debt, or all kinds of debt?

They present three categories, public debt securities, private debt securities and bank assets, and group them as "global debt", if I read it well.

[Admiral Yi]

They present three categories, public debt securities, private debt securities and bank assets, and group them as "global debt", if I read it well.

Well I'm wondering how much of that is expansion of consumer credit in previously underserved markets, like China and India.

[Iormlund]

Our spreads didn't skyrocket until very recently, when investors were convinced by Merkel and the ECB that the Euro was in actual danger, something most would have thought crazy talk a few months ago.

The "PIIGS" thing has been around for much longer than just "very recently", so arguing that everything was fine in Italy and Spain before Merkel and the ECB "convinced" investors that there was danger is a bit strange.

Take a look at hard data. As Minsky has already pointed out, Spanish, Belgian, Italian and French spreads started climbing this summer, all at the same time. Driven not by change in their fundamentals, but by widespread loss of confidence in the EZ, years after the crisis started.

[The Minsky Moment]

How was the entire project premised on de facto guarantees? 

Because that was the message that was communicated to the market.  Greece for example was allowed to enter despite the fact that it had not satisfied the entrence criteria, with the explanation being that it didn't really matter because the Greek economy was so small it didn't pose an overall risk to the Eurozone.  The markets interpreted that as a de facto guarantee of Greek national debt, and interest rates converged accordingly.  The same phenomenon occurred with Portugal and other "peripherals" although at least there the convergence criteria were applied more seriously.

The US states issue dollar denominated debt without a federal guarantee.

Different institutional arrangement.  Most US states can't run budget deficits; in return, they get large block grants and other aid from the federal government.  State capital projects can be bonded but they are stand-alone obligations.

If the entire project was premised on de facto gurantees it would have been a real good idea to get the most likely guarantors agreement in principle.

In part that was what the debate over the growth and stability pact in the 90s was about.  Germany sought to cabin the de facto guarantee risks by insisting the other countries abide by strict fiscal rules.  But the pact proved ineffective when all the core countries -- including Germany itself- breached it and then refused to impose any meaningful sanction.

Its true is retrospect, there should have been a more open and honest discussion about what would happen in the event of crisis.  But the politicians had little interest in raising such matters directly in front of their electorates.

I thought the entire project was premised on eliminating exchange rate risk and providing the southerners instant central bank credibility.

The latter is an incomplete statement.  The project assumed that there would have to be economic convergence of the weaker Eurozone members.  Concretely that was achieved to a significant extent by convergence in interest rates.  Thus, for example, Portugal's candidacy and eventually admission was accompanied by an extraordinary reduction in interest rates.

The mechanisms for interest rate convergence were twofold: (1) improved inflation-fighting credibility and (2) lower perceived credit risk.  But of those two, #2 was the more important factor.  Because part of the Maastricht criteria for admission in the first place was that the candidate had to have a credible central bank and establish a track record of low inflation performance.  So while admission bolstered that credibility somewhat by making even more difficult to interfere with central bank independence, it was only an incremental impact. 

The big impact was the market perception of lower credit risk, and that is the only way to explain the extraordinary convergence in rates prior to the financial crisis.  Foe example, in early-mid 2008 Italian 10 yr spreads over Bunds were only 20bp despite a debt-GDP ratio over 100%; Portugese spreads were in the range of 12-15bp, and Greece around 25 bp(!)  That was just 3 years ago.

But joining a currency union in itself does nothing to lower national credit risk.  On the contrary, it tends (all else equal) to make it worse, because it removes devaluation as a potential tool for economic adjustment and locks in less competitive countries into what may be them an uncompetitive exchange rate.  So the only basis for the market perception of lower national credit risk was the assumption that Eurozone states and the ECB would take care of the weaker players if push came to shove.

[Admiral Yi]

Not much to disagree with there Joan.  The big difference between us is you think Germany is a dirtbag for running out on its undeclared, unwritten, and unspoken obligations, whereas I think lenders were retards for assuming a guarantee where none existed.

[The Minsky Moment]

The big difference between us is you think Germany is a dirtbag for running out on its undeclared, unwritten, and unspoken obligations, whereas I think lenders were retards for assuming a guarantee where none existed.

Kind of, but I don't like using the language of value judgments in this context (the Night Train thing was just for show).  Everyone is trying to pursue what they think their interests are and respond to those incentives that exist.

My criticism of German policy is that it has been self-defeating.  Germany talked the moral hazard talk, but when it come time to walk the walk, it suddenly noticed that it was out on a plank.  Skipping the mixed metaphors - the Euro has been very good to Germany overall, and from a purely rational self-interested calculation, it makes sense to pay a price to keep it together.  But by talking tough and dragging its feet in the early stages, Germany raised that price substantially.

As for the market participants and dealers in European sovereign bonds, the nature of markets is to seek comfort in the herd, and extrapolate out from past experience.   For well over a decade, the markets have acted as though the Eurozone had eliminated single country credit risk through collective solidarity, and the national members acted consistently with that assumption, and certainly didn't do or say anything to counter that impression.   It is easy to say that market participants shouldn't have been so trusting in their assumptions, and that their mistake is their problem.  Only it is not just their problem - because the exposure to loss is concentrated heavily in systemically important financial institutions, and in the customers, counterparties and debtors of those institutions.  So like it or not, it is a national problem.

[Admiral Yi]

Changing the subject slightly, one theme running through your posts is the notion that default and dissolution of the EZ are inextricably linked.  I don't see why that's the case.  As I've mentioned before, once a country has defaulted their primary motivation to leave the common currency--independent monetary policy and the ability to inflate away debt--is gone.  Or the obverse: the country doesn't default but can't inflate away the debt because its denominated in a foreign currency.  Latin America couldn't inflate away dollar bonds.

[Sheilbh]

I don't see the big threat to the EU as a whole.

Okay.  I suppose I don't trust the pilots who lose control of the plane to somehow successfully negotiate the crash landing.  I also think if it's reaching the point where we're effectively saying 'well Europe's a collection of sovereign states, so Euro-legal structure be damned we'll do this anyway' then the EU's effectively failed.  The credibility's gone and we're moving to something else entirely.

Different institutional arrangement.  Most US states can't run budget deficits; in return, they get large block grants and other aid from the federal government.  State capital projects can be bonded but they are stand-alone obligations.

The Federal nature matters.  I don't know that the dollar would hold together so well if, say, New Hampshire had to vote for block grants and subsidies to Alaska.  The central arrangement in Washington, with credibility and legitimacy everywhere allows that to happen in a way that simply isn't the case in Europe.

Quite a scary interview with former deputy governor of the BofE just now.  Though he still thinks Europe'll resolve the crisis.  Though it's 60-40.

Personally I wonder if we've enough political capital to solve it.  I don't know that we can get something like the global action taken in 2008-09

[dps]

They present three categories, public debt securities, private debt securities and bank assets, and group them as "global debt", if I read it well.

Well I'm wondering how much of that is expansion of consumer credit in previously underserved markets, like China and India.

Can't tell just from the graph, but the rate of growth over the last 3 years is nowhere near 11%--in fact it looks flat for the last 2.  The 11% is the average rate over the last 10 years.

There's nothing really surprising here.  I don't find the statement, "currently global debt is the highest in history for a peacetime period, and has grown yearly by 11% since 2002, while global GDP has only grown 4%" to be at all unexpected.  I might not have been able to guess the numbers particularly accurately, but the overall situation is about what most people would think to be the case.

[The Minsky Moment]

Changing the subject slightly, one theme running through your posts is the notion that default and dissolution of the EZ are inextricably linked.  I don't see why that's the case.  As I've mentioned before, once a country has defaulted their primary motivation to leave the common currency--independent monetary policy and the ability to inflate away debt--is gone. 

A primary motivation to leave the common currency is to be able to devalue and restore competitiveness to the real economy.

Start with Greece.  Let's say Greece were to default and the immediate collateral damage contained, which is theoretically possible to do.  Greece would be left with a managable debt - but it would also still have a shrunken economy, no way using state spending for stimulus . . .  and, it would still have its unsustainable 9% current account deficit.  So the immediate problem is solved but the underlying problem remains.  And within the Eurozone the only solution is massive deflation in Greece or inflation in the net exporting countries.

If the problem can't be contained within Greece, the problem takes on a different dimension.  Italy alone has over Euro 2 trillion in debt and a default could wipe out banks all over Europe (French banks in particular are heavy investors).  If things get tough, the Italians may decide they are better off exiting the Euro and paying off their debt in depreciated lira AND getting the side benefit of an export boom. 

At this point an interesting game theory exercise plays out.  Lets say you are an Italian or Spaniard with a nice fat bank account currently denominated in Euro.  If you start to think (rightly or wrongly) that an exit from the Eurozone is a plausible outcome, you have a strong incentive to move that money to a "center" country like Germany, rather than risk possible forced conversion to new peseta or lira.  Of course if such capital flight occurs, it deepens the hole by weakening domestic lenders and removing taxable funds from the country, thus increasingly the likelihood that a exit will occur or at least that the increasing the perception of the risk that an exit may occur.

Now imagine you are a German central banker or Chancellor and contemplating the possibility of an influx of Italian or Spanish deposits.  Seems real nice for Germany . . . unless of course Italy/Spain ditches the Euro.  Then you have an inflationary disaster scenario on your hands as Spaniards and Italians now have massive Euro denominated claims which can be used to purchase German goods and assets, but in return the German banking system now only has claims on Italian banks that are denominated in depreciated new peseta and lira (assuming they are collectible at all).  Since imposing capital controls would breach EU rules, the only surefire protection against this scenario is if Germany pre-emptively exits the Euro itself before this can all play out.

So the danger is a prisoner's dilemma scenario where all sides would be better off staying in if everyone would agree to stick together, but absent foreknowledge of what the others will do in the future, there is a powerful incentive to defect.  The more people start thinking that exit is a possible outcome, the more likely it is to actually come true.