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Countries that might try to nip
Jul. 6th, 2010 01:44 pmNow, is it the banks that are broke or the governments? Or both? Back in the land of sovereign debt, Standard & Poor's now rates Greek debt at BB+ , which I class a degree of optimism that has little contact with reality. Tucked away in a rarely read part of the FT this morning is a listing of the 10 "riskiest" countries and the cumulative probability of default over the next five years, if the credit default swap markets are to be believed.
One quick caveat here. The CDS markets are as vulnerable to greed and fear as any other part of the market. Even though the bet might be absolute (i.e., there is actually a "right" answer), the emotion surrounding it is not. That said, if you want to get protection from a triple A company against $10m of Greece's bonds defaulting between now and 2015, it will cost you $100,340 a year. For slightly technical reasons, this equates to an implied 55.6% chance of default (for those of a mathematical bent greater than mine, you can read the last couple of pages of this; http://www.securitization.net/pdf/content/Nomura_CDS_Primer_12May04.pdf
which shows how you don't just take the value of the bonds and the value of the premium to work out the likelihood of default). That gives an implied rating of CCC, not BB+
The good news for Greece is that it isn't the riskiest country in the world. The bad news is that the only country that is thought to be riskier than Greece is Venezuela. Third place is Argentina, which is not a surprise. I think that Argentina has been in the top three for the past 300 years.
The important point here is that sovereign debt defaults do happen, and the sky doesn't fall. The world (ok, Germany) is being misled by its own promises when the eurozone was created. Should Greece trigger a "credit event", the world will not come to an end. Even the euro might not come to an end.
The main "that was then and this is now" difference is that in the old days you had the junk-bond countries, often in the emerging markets, and you had the developed world markets, where that kind of thing did not happen. That differential has now vanished. Not only are European countries such as Romania, Latvia and Bulgaria up there with Iraq and Pakistan, but the countries that are getting less safe the quickest are, universally, countries in the first world. Guess which four countries saw the most rapid deterioration in their "default-likelihood" in the past quarter?
Step forward Spain, Portugal, Belgium, and France.
What this means, of course, is not that France suddenly got riskier than Italy. What it means is that investors have come to realize that, not only is Italy a basket case (as they knew all along), but that France is inextricably linked to Italy. So, if France isn't in the same basket, it might well be in the basket next door.
For France, this is not a first. In the early 18th century it had a debt of 3bn livres, an income of 145m livres and a fixed expenditure of 142m livres. As even the most economically challenged wil realize, 3m livres wouldn't cover the interest payments on 3bn livres of debt.
In this particular instance, the wealth all went to the bad old (dead) king -- Louis XIV, I think. So the populus were rightfully upset that they were being asked to pay for it. Today, the bankers have been cast in the mold of the old dead king, whereas in fact, the money has gone to us -- we just haven't recognized it. We thougght it was our own "cleverness" as the asset bubbles were created and we remortgaged and bought better cars and had better holidays and extended the house "because we were expecting a third child". YOU COULDN'T AFFORD THE THIRD CHILD, KNUCKLEHEADS.
A common thread in many of the sensible public responses to posts by Stephanie Flanders and Robert Peston is that it's a matter for debate whether the democratic tradition is strong enough to withstand the inevitable economic strains that countries are going to suffer. We move, in other words, from economic upheaval to political upheaval.
Political upheaval is, in a way, an acceptance that the free market has failed. If society crumbles, then the free market just hasn't done its job, which is to make everybody better off, although not at an equal pace. The free market might have led to the highest overall wealth, but it failed to keep society functioning while doing so. If millions of people are lynching bankers on the way to work, it's not much use saying "but look how well off the country is as a whole", because the lynchers ain't listening.
Perhaps, once again, this comes back to the politically naive person's frequent belief in two correlated and misguided factors -- morality and fairness. Society and politics are not about justice, fairness, or morality, so stop using those words, for goodness' sake. Society and politics are about what works, what functions, not "what would be nice". The verb "should" has no place in it.
So, the trick of the economists will be to come up with some kind of plan that doesn't begin with the phrase "I wouldn't start from here", and the trick of the politicians will be to sell it to the voters without finding themselves joining the economists and bankers, hanging from the nearest lamppost.
My own favoured line is really that of the "war footing". The way in which many economies in the past have coped with messes of their own creation is to look for a scapegoat -- the Jews in Germany were only one in a long line of such strategies throughout history. You then have to find an external enemy as well, and you have to sell to the public that, if we can just defeat these internal and external enemies, everything will be hunky-dory in the garden. But unfortunately there will be some suffering and sacrifice on the way.
Can you get the public to accept the suffering and sacrifice without a scapegoat that puts things in simpler, black and white, but wrong, terms? Is the public sophisticated to understand the concept of a war that does't have an easily recognizeable "baddie"? Perhaps not, but it must be worth a try.
__________
____________________
One quick caveat here. The CDS markets are as vulnerable to greed and fear as any other part of the market. Even though the bet might be absolute (i.e., there is actually a "right" answer), the emotion surrounding it is not. That said, if you want to get protection from a triple A company against $10m of Greece's bonds defaulting between now and 2015, it will cost you $100,340 a year. For slightly technical reasons, this equates to an implied 55.6% chance of default (for those of a mathematical bent greater than mine, you can read the last couple of pages of this; http://www.securitization.net/pdf/content/Nomura_CDS_Primer_12May04.pdf
which shows how you don't just take the value of the bonds and the value of the premium to work out the likelihood of default). That gives an implied rating of CCC, not BB+
The good news for Greece is that it isn't the riskiest country in the world. The bad news is that the only country that is thought to be riskier than Greece is Venezuela. Third place is Argentina, which is not a surprise. I think that Argentina has been in the top three for the past 300 years.
The important point here is that sovereign debt defaults do happen, and the sky doesn't fall. The world (ok, Germany) is being misled by its own promises when the eurozone was created. Should Greece trigger a "credit event", the world will not come to an end. Even the euro might not come to an end.
The main "that was then and this is now" difference is that in the old days you had the junk-bond countries, often in the emerging markets, and you had the developed world markets, where that kind of thing did not happen. That differential has now vanished. Not only are European countries such as Romania, Latvia and Bulgaria up there with Iraq and Pakistan, but the countries that are getting less safe the quickest are, universally, countries in the first world. Guess which four countries saw the most rapid deterioration in their "default-likelihood" in the past quarter?
Step forward Spain, Portugal, Belgium, and France.
What this means, of course, is not that France suddenly got riskier than Italy. What it means is that investors have come to realize that, not only is Italy a basket case (as they knew all along), but that France is inextricably linked to Italy. So, if France isn't in the same basket, it might well be in the basket next door.
For France, this is not a first. In the early 18th century it had a debt of 3bn livres, an income of 145m livres and a fixed expenditure of 142m livres. As even the most economically challenged wil realize, 3m livres wouldn't cover the interest payments on 3bn livres of debt.
In this particular instance, the wealth all went to the bad old (dead) king -- Louis XIV, I think. So the populus were rightfully upset that they were being asked to pay for it. Today, the bankers have been cast in the mold of the old dead king, whereas in fact, the money has gone to us -- we just haven't recognized it. We thougght it was our own "cleverness" as the asset bubbles were created and we remortgaged and bought better cars and had better holidays and extended the house "because we were expecting a third child". YOU COULDN'T AFFORD THE THIRD CHILD, KNUCKLEHEADS.
A common thread in many of the sensible public responses to posts by Stephanie Flanders and Robert Peston is that it's a matter for debate whether the democratic tradition is strong enough to withstand the inevitable economic strains that countries are going to suffer. We move, in other words, from economic upheaval to political upheaval.
Political upheaval is, in a way, an acceptance that the free market has failed. If society crumbles, then the free market just hasn't done its job, which is to make everybody better off, although not at an equal pace. The free market might have led to the highest overall wealth, but it failed to keep society functioning while doing so. If millions of people are lynching bankers on the way to work, it's not much use saying "but look how well off the country is as a whole", because the lynchers ain't listening.
Perhaps, once again, this comes back to the politically naive person's frequent belief in two correlated and misguided factors -- morality and fairness. Society and politics are not about justice, fairness, or morality, so stop using those words, for goodness' sake. Society and politics are about what works, what functions, not "what would be nice". The verb "should" has no place in it.
So, the trick of the economists will be to come up with some kind of plan that doesn't begin with the phrase "I wouldn't start from here", and the trick of the politicians will be to sell it to the voters without finding themselves joining the economists and bankers, hanging from the nearest lamppost.
My own favoured line is really that of the "war footing". The way in which many economies in the past have coped with messes of their own creation is to look for a scapegoat -- the Jews in Germany were only one in a long line of such strategies throughout history. You then have to find an external enemy as well, and you have to sell to the public that, if we can just defeat these internal and external enemies, everything will be hunky-dory in the garden. But unfortunately there will be some suffering and sacrifice on the way.
Can you get the public to accept the suffering and sacrifice without a scapegoat that puts things in simpler, black and white, but wrong, terms? Is the public sophisticated to understand the concept of a war that does't have an easily recognizeable "baddie"? Perhaps not, but it must be worth a try.
__________
____________________
