Europe’s at it again…
Key European CDS are starting to turn in the more northern direction again, as the German-French ‘pact for competitiveness’ faces near-unanimous pushback across Europe.
Credit default swaps (CDS) are a market security used by investors to buy 5-yr protection (in this case) against default (or the like). As the spread rises the implied probability of default does too. Current market values imply a 39% probability of default by the Irish sovereign (listed in legend), 20% by that of Spain, and 14% by the Italian sovereign, etc. Cash bond spreads are blowing out again, too, where Spain now must pay a 216 bps premium over Germany on a 10-yr loan (the sovereign bond). I’d say that’s not totally irrational.
I completely understand why these negotiations are stalling. I’m Spain – it’s not clear that Spain commented against the pact based on this article, but I digress – why would I agree to a deal that forces more ‘competitive’ measures, which really just means quashing indexed wage growh, reducing the government deficit, adhering to a fiscal policy rule (which, by the way should be modeled after Germany’s debt brake), and adopting a standardized tax rate? Okay, I will if you (Germany) will. Meaning, I’ll increase my competitiveness by stripping away aggregate demand if you allow prices to rise. I’m Germany – no way. (Please see my previous post which argues that a successful transition to a more stable Eurozone depends on higher Germany inflation.)
Der Spiegel spells it out pretty succinctly in an article that is now two weeks old but still totally relevant:
Germany will only agree to additional guarantees for the euro rescue fund — as the Commission and other parties have called for — if its partners approve its competitiveness pact.
Simply put: we (Germany) will only agree to eventually bail you out if you agree to our harsh demands at that time, or you agree to our harsh demands now. You’re choice.
This political drama is far from over. (More exciting analysis below the jump)
(Dan here…Kantoos responds to Rebecca…http://kantoos.wordpress.com/2011/02/15/rebecca-wilder-on-eurozone-monetary-policy-and-german-inflation/ )
Here’s another little fact to think about: The price to buy protection against a default by the Japanese sovereign is just 77 bps, that’s only 23 bps above that for the German sovereign. This is ironic because Germany is the premiere demander of fiscal austerity, while Japan is not (to say the least) with gross debt equal to 221% of GDP (according to the IMF) – or is it?
The table below lists common characteristics usually associated with rising CDS spreads (CDS spreads are current as of 4pm today and may vary according to pricing source): the stock of debt held by foreigners (any currency denomination) and the stock of gross public debt. The final column illustrates the ability of a country to print fiat currency that is not backed by anything but government decree.
I think it’s pretty clear: Japan and the US have very elevated government debt, but low external holdings AND can print their own money to finance liabilities (which by the way are in most part denominated in their respective currencies). Clearly markets’ attach weight to this simple fact via low CDS spreads.
To be continued….
Rebecca Wilder
Rebecca,
Its Germany’s money. They get to set the terms…I’m not sure why that so difficult to understand.
The PIIGS don’t have to take the money and can get out of this without aid if they don’t like the terms. Its time for the PIIGS to get their fiscal house in order, which they really, really don’t want to do. The US doesn’t want to either, but so far our creditor hasn’t demanded anything and we still have the ability to print money as we see fit.
Would you invest in Greece?
Islam will change
If I were one generation closer iwould have Irish citizenship, in that case the prospects for Irish default would be closer to 100%.
The Irish voters should out the government and elect a parliament which works for them not Bundesbankers.
I would vote the PM and party out……………………
Same for Greeks!
And Portugal, Spain………………
ilsm will not change.
Rebecca,
I am a little confused. Growth in CDS spreads combined with possible action by the ECB (your previous post) appear to present a problem for the economic recovery in Europe. Am I missing something on that point? Will it not be a double hit? Or is that already factored in to the cost of doing business in any part of Europe?
Thanks for referencing the IMF Fiscal Monitor. I have forgotten to read the most recent issues. I am working my way through the November issue, then on to January brief update.
Gee MG:
Bets on the failure and countering bets on its success. All placed on Wall Street and the European Market. The greater the spread, the greater the probability of either failure or success.
ok, the external debt of all these European countries is higher than in the US, Japan. but how much of this debt is actually held by parties outside of the EU/eurozone?
I assume a lot of this debt is cross-EU countries. German banks are famously deep into the Irish and Greek debts. would/should this be qualified as outside debt?
From whom do you think Germany derived all that ‘money’ and excess savings? Yep, from the European Union and to a lesser extent, the Eurozone (roughly 48% of its export income, if memory serves). The Germans have beniffited from years of current account deficits by the Periphery countries. The German real exchange rate is too low.
No, I would not invest in Greece! Perhaps Greek real estate (if able to, of course) – but not Greek sovereign bonds.
Rebecca
My bet’s on Ireland to be the first to default. They’ve got a history of voting against the consensus for matters EU/Euro zone. Also, Lenihan is public in his desire to re-negotiate the terms of the Euro zone/IMF loan. Junker says this is a possibility, but will the Germans acquiesce?
EVentually the government will not be able to ‘sell’ fiscal austerity to the population any longer, all to support the banks.
When would you have defaulted? 2007? If so, you could have prevented your country from years of repression and debt deflationary hardships.
Rebecca
@ MG: “Growth in CDS spreads combined with possible action by the ECB (your previous post) appear to present a problem for the economic recovery in Europe.”
No need to be confused, this is entirely consistent with my views. Fiscal austerity won’t ‘work’ in this environment. At the very least, you need strong external demand (Germany) to get Spain or Portugal out of its debt hole – not enough there. Then you have an ECB that wants to stem a banking and liquidity crisis through fiscal austerity…. sure they’re buying bonds, but they’re sterilizing the flows (i.e., the net effect on the aggregate economy should be zero). Eventually, the ECB will be buying bonds in mass, but that will be after a really big banking event.
All policy is too tight.
Ah yes, the good old IMF fiscal monitor. It has a wealth of public statistics, but kind of missing the other parts of the economy. When discussing the desire for public saving, a contemporaneous discussion of the current account and PRIVATE saving is necessary – they totally disregard this static equilibrium that is an axiom of national income accounting (i.e., they don’t mention the overly levered Spanish private sector whose desire to save has sky rocketed with minimal chance for export growth, in my view)…
Oh, and I forgot to reference this in the table – the external debt data comes from the World Bank Quaraterly External Debt Statistics.
Rebecca
run, you are right about the CDS market – highly speculative and not regulated. However, it is one of the only market indicators of default (besides the rating agencies, which in my view are worse!).
Rebecca
My bet’s on Ireland to be the first to default. They’ve got a history of voting against the consensus for matters EU/Euro zone. Also, Lenihan is public in his desire to re-negotiate the terms of the Euro zone/IMF loan. Juncker says this is a possibility, but will the Germans acquiesce?
EVentually the government will not be able to ‘sell’ fiscal austerity to the population any longer, all to support the banks.
When would you have defaulted? 2007? If so, you could have prevented your country from years of repression and debt deflationary hardships.
Rebecca