Wednesday, April 21, 2010

More Sovereign Default Risk May Be On The Horizon

As the developed economies of the US and other countries continue to accumulate levels of debt not seen since WWII, the IMF has warned that there is the danger of higher interest rates and slower growth that could threaten global economic recovery. As the debt crisis in Greece demonstrates, unless other countries stop increasing their entitlement spending, it is only a matter of time before they, too, will have to take drastic measures to avoid currency devaluation. See the following post from Expected Returns for more on this.

From the Washington Times, IMF: Mounting debt threatens global recovery:
Historic levels of government debt in the developed world could throw the global financial system back into crisis and clear plans are needed to bring it under control, the International Monetary Fund said Tuesday.

In one of its first broad surveys since the recent recession gave way to renewed growth, the agency said that "sovereign risk" -- the chance that sovereign nations have racked up so much debt they won't be able to borrow enough money to pay their bills -- is now perhaps the central threat to the global financial system.

Governments in the United States and across Europe have accumulated levels of debt not seen since World War II as the recession crimped tax receipts, spending rose on entitlement programs, and emergency measures were put in place to support the economy.
The staggering debt levels in developed economies will be of concern in the years ahead. To put it plainly, it's time to pay the piper for years of debt accumulation. Investors will have to reasses whether current yields are justified in light of the risk of currency devaluation. Current yields are more a function of speculation and direct government intervention than fundamentals. In the end, fundamentals always win.

Gold at $1,140 dollars suggests that sovereign debt remains an issue for investors. The simple-minded will tell you gold is a bubble; the truth is, gold is the canary in the coal mine signalling sovereign debt concerns.

Interest Rates Rise, Death Spiral Begins

"The crisis has lead to a deteriorating trajectory for debt" among developed countries, which could cause higher interest rates and slower growth and weaken the broader financial system, the IMF said. Government debt could "take the credit crisis into a new phase, as nations begin to reach the limits of public sector support for the financial system and the real economy."

The most acute government debt problems are currently in Greece, whose government is negotiating a rescue plan with the IMF and other European nations but has already had to cut social benefits and raise taxes.

"Greece is a wake-up call" for the rest of the developed world, IMF's head of capital markets, Jose ViƱals, said at a briefing about the report.
The debt crisis in Greece is just the tip of the iceberg. Time will tell if the Greek economy can recover with the austerity measures imposed upon them. If the potential bailout of Greece follows the pattern of previous IMF bailouts, then the Greek economy is in a lot of trouble. The Euro will come under pressure as the larger European economies follow the path of Greece to default. When Greek debt is trading hundreds of basis points above German debt, you have to start questioning the sustainability of the Euro.

The high yields on Greek debt underly how sovereign risks dictate interest rates, not increasing economic activity. Make no mistake about it: when long-term interest rates in America rise, it will be because of sovereign debt.

Americans should get used to the death spiral Greece finds itself in. Higher bond yields will redirect government revenue to creditors, which weakens the budget position of Greece. The Greek government will raise taxes further in a knee-jerk response, leading to more civil unrest and a stagnant economy. Global players will be searching for a complicated solution to this never-ending crisis when the solution is rather simple. It's called stop spending, stupid.

This article has been republished from Moses Kim's blog, Expected Returns.


Anonymous said...

The situation in developing countries are much better now when it was a year ago. They are working hard for recovery.

I just could not understand that why developed countries still in trouble. They need to work hard!

Paul Ward said...

...It's called stop spending, stupid...

And that really is your conclusion? Stop spending in the real economy, eliminating any chance of real recovery - just feeding more cash to so-called investors to create ever new bubbles to burst. What happened to Econ 101? Replaced by Finance 101, or Money 101, or Greed 101?

In Jamaica we call it debt slavery - a product of easy money in the 1970s followed by hiked interest rates to deal with rich-country inflation, liberalisation adive by the IMF in the early 1990s leading to our own banking meltdown, and then the WTO replacing controlled trade with free / unfair trade.

The banking sector is supposed to lubircate the real economy, not be a parasite, not wreck it at regular intervals, not make ordinary people poorer than they were before. And don't say we have been borrowing to live beyond our means - its only Americans (USA) that have been doing that since WW2, living on a bubble, privileged by the almighty dollar...

Long live the resistance in Greece, Iceland, India and elsewhere.

InvestorCentric is certainly the right name for your website, or should it be InvestorMyopic?

Will your moderator(s) allow this through? I wonder..

Eric Ames said...

Of course we are going to allow your comment, as we encourage debate and discussion amongst our readers. The only comments we will not allow are ones that include profanity, and of course the SPAM ones.

That being said, keep in mind that this is just one blogger's opinion, not necessarily ours. We try to include content from a wide variety of bloggers to keep things fresh and interesting. You will note a completely different take on this topic from some of our other contributors.

We love to see debate on all topics, though, so keep it coming.