Sovereign debt bubble thread

[Jacob]

It gets more complicated if a purely private debt is at issue.

In that case the leglisature can declare the new currency legal tender for all debts effective immediately and with retroactive effect; barring constitutional challenge, that pretty much ends the matter for all purely domestic debt and probably all cross-border transactions under domestic law.

For foreign law cross-border transactions, the creditor can enforce the original terms overseas; but if the debtor has no property outside the exiting country, as a practical matter that judgment will be hard to enforce against him.

How will transnational corporations deal with this? They'll both owe and be owed large amounts of euro. Sounds like it could get pretty messy.

[The Minsky Moment]

Sounds like it could get pretty messy.

[MadImmortalMan]

When we all started posting on Paradox, there were not yet any euros in circulation.


...Amazing how quickly things happen.

[Neil]

The borrower doesn't get to redenominate its debt. The state will do it for him, just as it will redenominate its savings.

I'm not sure that's possible.  You owe me 100 euro, and tomorrow the Spanish government tells me you owe me 100 pesetas?

Of course.  The state's power is pretty much unlimited.

[Sheilbh]

I'm not sure that's possible.  You owe me 100 euro, and tomorrow the Spanish government tells me you owe me 100 pesetas?

It's necessary.  Either the government force converts everything or it defaults.  Especially if, as is likely, there's disruptions to trade which would make getting Euros difficult and capital controls fail.

As I say a couple of banks have noticed corporates starting to move their Euros from Spain and Italy into Germany.

One thought I have is what happends to Central Bank reserves?  I know some would have to be negotiated back from the ECB.  But in general isn't a large proportion of Euro-Central Bank reserves in Euros?  How will they be able to exchange if it looks like the Euro is collapsing?  What about other banks holding Euro reserves?

[alfred russel]

The reason I think it is important for the euro to disappear if some countries break away, is what happens in a contract between a US and Spanish entity that is denominated in euros and lists a US jurisdiction as the applicable governing law? I would guess in some of these cases the Spanish party is going to need to pay in euro, which would not be good with their new depreciated pesata. But if the remaining eurozone countries formally retired the euro for a new currency (maybe the "european"?), then it would seem more likely the company could pay in pesatas.

[Admiral Yi]

Seems to me that even if the euro were to completely disappear as a national currency you'd still have swap and forward contracts operating until all euro denominated positions are unwound.  Couldn't these be used to fix the amount of pesetas needed to fulfill the contract?

[alfred russel]

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.

I disagree on the details, not the result. Some states inability to run a deficit doesn't reduce their chance of default--it actually increases it in some cases (see California). They also don't get federal for the arrangement.

The differences are that a) with 50 states and the federal government responsible for most government spending, no state is going to produce a large contractionary effect through a default, b) the effect if a state does need to pursue a severely contractionary fiscal policy is reduced by the federal transfer payments that will go to the state and reduced tax burdens on the citizens, c) the federal government will be able to stand by the banks in the state.

[alfred russel]

Seems to me that even if the euro were to completely disappear as a national currency you'd still have swap and forward contracts operating until all euro denominated positions are unwound.  Couldn't these be used to fix the amount of pesetas needed to fulfill the contract?

I don't know, but that seems incredibly complicated. I would think the best course would be to rapidly get all euros and euro related assets and liabilities out of circulation asap, including the swap and forward contracts.

[Sheilbh]

I thought this may be of interest given your conversation:

Eurozone crisis: Britain's companies prepare for life after the single currency

Contingency planning for a breakup of the eurozone is already under way at UK-based multinationals

Britain's biggest companies are thinking the unthinkable and planning for the collapse of the euro. Multinationals such as Diageo, GlaxoSmithKline, Unilever and Vodafone are looking at contingency measures in case the single currency falls apart.

Pharmaceuticals giant GSK says: "As part of our standard risk management practice, GSK has undertaken planning to optimise its operations in the event of a country leaving the eurozone. This includes preparations to ensure uninterrupted flow of the funds that are needed to continue the operations of our business."

A Vodafone spokesman says the company is looking at each market individually as events unfold. It has already cut tariffs in Spain to take account of the weak economy and constraints on consumer spending. Asked what the company would do if the eurozone broke up, the spokesman says: "We are ready to implement contingency plans if the situation were to change significantly."

Companies are reluctant to go into detail about what they would do if faced with what analysts agree would be a financial catastrophe. But audit and risk committees, staffed by non-executive directors, are examining worst-case scenarios across Britain. "It would be remiss if they weren't looking at things very carefully at this stage," says one City consultant. "And that goes for any large British company with European exposure, especially if they are trading within the southern periphery."

Diageo, whose labels include Johnnie Walker and Smirnoff, is understood to have run computer models of how the business would look if the euro imploded, although that doesn't mean it is forecasting a meltdown. But Andrew Morgan, president of Diageo Europe, told the Financial Times: "We have started thinking what [a break-up] might look like. If you get some much bigger change around the euro, then we are into a different situation altogether. With countries coming out of the euro, you've got a massive devaluation that makes imported brands very, very expensive."

Unilever, whose brands include Ben & Jerry's ice cream and Dove soap, is apparently well placed because it generates more than half its sales outside Europe, from emerging markets. "But obviously a breach in the euro would hardly be good news for Diageo, or anyone else," says Graham Jones of Panmure Gordon.

Graham Leach, chief economist at the Institute of Directors, says that if "Club Med" countries came out of the euro, their national currencies would face "a dramatic devaluation of around 40%"; put another way, profits derived by UK firms in those countries would plummet when converted to sterling.

Leach says that an added risk would be significant asset writedowns for companies with operations in countries that had left the single currency. And there would also be "the most awful problems" over the honouring of contracts that were based on payment in euros. "There is no precedent for what could happen, so forward planning is difficult, to say the least," says Leach. He agrees that small firms could be disproportionately hit if they depend on exports to the continent, and some would inevitably go the wall.

Financial firms have been at the forefront of contingency planning in recent weeks. City interdealer broker Icap is testing its electronic trading platforms in case Greece leaves the eurozone and reintroduces the drachma. Spokesman Richard McCready said: "We have been testing our systems to allow customers to trade the drachma against the dollar and the euro. What we are doing would be a template that could be exploited if other countries also leave the euro."

Thomson Reuters says: "Our currency dealing systems are specifically designed so that we can add and remove currencies very easily and quickly. The systems are built and tested to cope with very significant volumes."

Hector Sants, the chief executive of the Financial Services Authority, has ordered Britain's banks to accelerate their contingency planning and his message was reinforced on Thursday when Bank of England governor Sir Mervyn King said UK banks should brace themselves to withstand the "extraordinarily serious and threatening" economic situation.

The Bank's financial policy committee said the eurozone crisis was the biggest threat to the UK's banking system, and banks should build up their financial buffers to withstand that. King said the Bank itself was making "contingency plans" itself in case of a eurozone break-up, without going into details.

Bank of America Merrill Lynch says a partial break-up of monetary union, with only some countries exiting the euro, is the most probable scenario, but still thinks a break-up is a far-fetched event. But that hasn't stopped financial institutions from hedging their bets. Barclays has slashed its debt exposure to Portugal, Italy, Ireland, Greece and Spain by 31%, from £11.6bn at the end of June to £8bn by the end of September. As well as allowing some government bonds to mature, Barclays has sold debt to willing buyers such as hedge funds.

And Prudential has taken "avoiding action" to dodge the European financial crisis with only £49m tied up in the debt of the worst-affected countries. Tidjane Thiam, the insurer's boss, said: "We started moving out of the eurozone countries after looking at their financial balance, the sovereign debt levels and their promises to pay."

The difficulty settling contracts would be enormous I think, especially as the guy quoted says, for small and medium businesses.  I imagine short-term it would simply mean a lot of contracts using third nation currencies like Swiss Francs or US Dollars surely?  But I've no idea practically

[Tamas]

So I read that the Italians announced austerity which at first glance sound promising.

Now Rome will burn but if they manage to keep control, it may benefit Europe. 

[Razgovory]

It gets more complicated if a purely private debt is at issue.

In that case the leglisature can declare the new currency legal tender for all debts effective immediately and with retroactive effect; barring constitutional challenge, that pretty much ends the matter for all purely domestic debt and probably all cross-border transactions under domestic law.

For foreign law cross-border transactions, the creditor can enforce the original terms overseas; but if the debtor has no property outside the exiting country, as a practical matter that judgment will be hard to enforce against him.

How will transnational corporations deal with this? They'll both owe and be owed large amounts of euro. Sounds like it could get pretty messy.

I was suggesting there might be problems with this kind of thing a few years ago.  The resident Euro-philes assured me that it wouldn't be an issue.

[Ed Anger]

So I read that the Italians announced austerity which at first glance sound promising.

Now Rome will burn but if they manage to keep control, it may benefit Europe. 

Bossi needs to march on Rome.

[Iormlund]

So I read that the Italians announced austerity which at first glance sound promising.

Now Rome will burn but if they manage to keep control, it may benefit Europe. 

Is there any country whose outlook has improved after undertaking austerity measures?

[stjaba]

So I read that the Italians announced austerity which at first glance sound promising.

Now Rome will burn but if they manage to keep control, it may benefit Europe. 

Is there any country whose outlook has improved after undertaking austerity measures?

Argentina