Posts tagged ‘default’

Cui Bono?

The continued negotiations over emergency lending to Greece have been an obvious political risk for some time, and one which increased with the change of government there in January. This week’s leading stories have been dominated by the latest down-to-the-wire developments. The shock deferral of a payment due to the IMF until the end of the month was followed by recriminations between the Greek government and its creditors at the highest political level and the IMF team itself has now stormed off from Brussels in despair: EU Prepares For Worst As Greece Drives Finances To Brink (Bloomberg)

We have already looked at the possible consequences, and certain pain, that would ensue following a Greek sovereign default (The Joy Of Negotiating). In any case an indebted Greece would still require emergency funding of some kind in the aftermath of such a default as the bond market would be closed. Its emergency creditors would likely be exactly the same bunch it is dealing with today, or wild card lenders like Russia or China who on the evidence of previous discussions would require security over the nation’s land or other assets that even Greece’s previous government was unwilling to consider.

The Greek public appears to be more alive to the reality of their situation than their government. According to a poll conducted at the beginning of the month, 47 percent disapprove of its brinkmanship (and 74 percent want Greece to remain in the euro).

Even as time truly begins to run out, however, markets are still relatively sanguine about the possibility of default. Peripheral country bond spreads to Germany have widened a bit but remain below levels reached last summer, before Greece resurfaced as an issue. The euro is 3% up on the month to date. Equity markets have shown some nerves but there have been absolutely no signs of panic in the pricing of haven assets such as US Treasuries or gold. This is nothing more than reasonable: Greece is a small economy (GDP of $242bn in 2013 on World Bank numbers, less than 2% of the eurozone total), so the level of contagion occurring naturally from its collapse would be relatively muted.

Which brings us on to the real tragedy of these negotiations: the effect they are having on Greece. Economic sentiment has withered back towards the level it occupied during the final quarters of the country’s last recession in 2013. The banking system has been weakened – again – by the offshoring of deposits. Another recession is guaranteed. This is doubly disastrous when one considers that the budget deficit last year, at €6.4bn, was its lowest since 2000 and down from a peak of €36.2b in 2009. The country had exited recession, was running a primary surplus, meeting its debt obligations and seeing the number of unemployed decline for the first time since 2008. That has all been thrown away. Only yesterday employment data showed that the economy has gone back to shedding jobs. And in a year when European growth and consumer spending have been picking up notably and the currency is internationally weak, Greece’s key tourism industry might well have been expected to put on its strongest showing since the financial crisis. It would be astounding if the heightened uncertainty and bad press arising from the government’s actions have not turned many of those tourists away now.

The bottom line is that Greece needs its credit lines more than its creditors need to spend time playing games with the Greek government. The question the members of that government ought to be asking themselves, again and again, is: who benefits?

Let us leave the last word to an economist quoted in this post’s first linked article:

“People are really fed up with this,” UniCredit SpA Chief Global Economist Erik Nielsen said in a television interview. “They’ve never seen anything so completely ridiculous, frankly speaking, from a debtor country.”

12/06/2015 at 4:10 pm

The Joy Of Negotiating

While they may not yet be making headlines across the broader media as in days gone by, the ongoing negotiations between Greece and her creditors are the subject of the most widely-read article on Bloomberg today. Entitled German-Led Bloc Willing To Let Greece Leave Euro, the piece has the following money quote from Edward Scicluna, finance minister of Malta:

Germany, the Netherlands and others will be hard and they will insist that Greece repays back the solidarity shown by the member states by respecting the conditions … They’ve now reached a point where they will tell Greece ‘if you really want to leave, leave.’

It is now nearly five years since the downgrade of Greek debt caused worldwide panic over the condition of Europe’s sovereign balance sheets, and for much of that time there have been some who have advocated euro withdrawal and default as the solution to the country’s problems. Somewhere near the zenith of this view’s popularity readers may remember that it was Titanically flawed:

First of all, the currency … There would be rapid depreciation – indeed, the possibility that [it] could cease to be transferable internationally. (The Icelandic krone threatened this at the nadir of the recent crisis with the result that the supply of imported food was jeopardized.) Even if the drachma were tradeable, immediate, rapid inflation would occur. At the same time, bank deposits and other assets would have to be re-denominated, decimating the wealth of the nation overnight. These twin effects would demolish household and business consumption and consign the country to a further period of sharp economic contraction.

All well and good, say the defaultists. But at least Greece would be free of her debt!

Yes, and no. Greece is still running a budget deficit and in the catastrophe scenario this would get worse. So unless the Greeks wanted total state shutdown, they would still have to borrow money. Who would be the lenders? The EU; the IMF: exactly the same people who are lending to them at the moment. The conditions imposed by those lenders – who would still have effective control of the country’s economy until their loans were repaid – would be at least as punitive as the conditions they’re imposing now. In other words, there would be at least as much austerity to contend with, and possibly more.

One key feature of the economic landscape has changed since then, however: Greece has been running a primary budget surplus since the middle of 2013. This means that, ignoring debt interest, the government is raising more in tax than it spends. The last available data from the Bank of Greece (for November) has this primary surplus running at 2% of GDP. There are suspicions that the position has deteriorated since, but the key point is that – in theory – the Greek government could walk away from its debt and let its creditors go hang as it would no longer need to borrow money.

Bearing in mind the point about the currency, banking system and the rest, this surplus would likely not last very long in the event of a “Grexit”, so it isn’t that strong a negotiating point. It does, however, make such a decision appear less obviously stupid. This might well reduce the extent to which political will is bent to economic fear. The Greek situation today is therefore arguably more volatile than it was in 2011.

This is certainly not how it seems. The market reaction to Syriza’s election and Greece’s return to the repetitive circus of down-to-the-wire debt talks every few months has been pretty muted. The country’s ten year debt is priced at over 60 cents on the dollar, below the 80 cent level reached before last autumn but nowhere near reflective of the 74% loss incurred by bondholders in the 2012 restructuring. The Athens Stock Exchange index has fallen 24% over the past six months, but that is pretty tame compared to the 69% fall it suffered over calendar 2010 and ’11 – and it is actually some 3% up on the year to date.

The overall market view, then, seems to be either that the current talks are nothing to worry about, or that Grexit doesn’t matter very much. And besides, the Euro Stoxx 50 is up 11% since the end of 2014, last week’s GDP data for the eurozone was a little ahead of expectations, today’s stronger-than-forecast PMI numbers suggested the outlook here remains bright, and while it has bounced a bit recently the oil price remains about 45% lower than where it spent the first half of 2014. (If you add up the individual members you find that the eurozone, not the US or China, is the world’s biggest oil importer by some distance.)

It appears highly unlikely that another major debt restructuring is on the cards for Greece (as opposed to changes to its existing terms). On this basis the relatively sanguine market view looks right. Prime Minister Tsipras could of course decide to give the world a shock, but it remains clear on balance that this wouldn’t do his country much good.

20/02/2015 at 4:47 pm


The United States has been a source of much consternation this year. First of all the Federal Reserve accidentally triggered a mild panic over one of its least efficacious policy programmes. Then Congress deliberately threatened to push the nation towards default to force the government’s hand over legislation passed by itself in 2010. It is almost as if elected representatives in Washington have become so disappointed with the failure of their European counterparts to provoke another global financial meltdown that they have decided to do the job themselves. This is an unusual attitude to American exceptionalism. And it is hardly intuitive to wave the cudgel of a selective default on US debt while claiming to do so in an attempt to bring US debt under control.

However, what Warren Buffett has rightly called the “extreme idiocy” of the present position has not had that much of an effect. This seems incredible given what might technically be at stake. Already, 70% of intelligence staff have been placed on unpaid leave; just enough employees at the Department of Energy have been left in post to discharge their responsibilities to supervise the nation’s nuclear stockpile; diplomacy has already been affected, though troops are still to be paid (and the postal service remains in operation). And yet the S&P 500 is only 2% off its record high of a couple of weeks ago. The trade weighted dollar has tumbled all of 1% over the same period. Credit default swaps – which are priced specifically to insure against the risk of sovereign default – have admittedly ticked up a bit, but only to 42bp. That isn’t even the high for the year. According to Bloomberg the US still prices in this market as the sixth safest debtor in the world (between Britain and New Zealand).

Compare and contrast this picture with the down-to-the-wire debt ceiling negotiations of July and August 2011. Back then there was pandemonium. President Obama and Congress between them hammered out a complex package of fiscal arrangements and at the eleventh hour managed to avoid the shutdown we’re now seeing – and markets collapsed. The meltdown which accompanied the events of that summer was truly savage (see this blog’s coverage here and here).

Something has clearly changed.

As was apparent from the start in 2011, the real trigger for the crash was not the political turmoil: it was downward revisions to US GDP, raising fears of a double dip recession. This occurred against the background of looming default for Greece, revolution across the Arab world, the obliteration of part of Japan’s east coast – in short, a climate of absolute fear.

And let us not forget that at that time, the US federal budget deficit was running at 8% of GDP.

Today the situation is very different. Markets are behaving with relative equanimity because the infighting on Capitol Hill really isn’t as important as the economic fundamentals – unless Buffet’s point of extreme idiocy is breached, of course. Today, the federal deficit is 4%, and falling. US GDP growth has been increasing (and the last set of backdated revisions saw the numbers go up this time). Unemployment is 2% lower, bank balance sheets are cleaner, the housing market has picked up, manufacturing is stronger – and Europe, too, seems considerably further from the brink of catastrophe than it was two years ago.

A particularly gifted politician might be expected to assimilate all these things without even thinking, adapting instinctively to the changed national mood. It certainly appears that the President has done so. In 2011 he conceded ground to avoid a shutdown which was posing an additional threat to confidence. This time round there have been no concessions. In fact, Mr Obama has ruled out negotiating with his opponents at all until the government is reopened and the debt ceiling raised. “I’ll negotiate with you only after you give me what I want.” It’s an insouciant stance to say the least, and so far, the damp squib shutdown appears to justify it.

We ought not to be one-sided. The healthcare reform so vehemently opposed by many Republicans has been controversial from the start and unwieldy to implement. And without their intransigence back in 2011 that budget deficit would likely not have been repaired to the extent that it has. The US debt burden is huge, and such a position brings with it expense and vulnerability.

Nonetheless, the President is on the right side of the markets’ mood and the economic undercurrents this time – so long as he can avoid a sovereign default. At that point, CDS at 42bp would begin to look like something of a bargain …

04/10/2013 at 5:31 pm

Recent Posts