Monday, November 22, 2010

The PIGS have their problems, but Europe is not melting down

Portugal, Ireland, Greece and Spain are still having sovereign debt problems. Even though the EU is working hard to patch over the problems, credit default spreads for these issuers have risen significantly. Once again the world is worrying whether these problems will lead to the collapse of the euro and/or serious problems for European economies.


As this chart of swap spreads suggests, the problems, while serious, are not nearly as bad today as they were at the peak of the global financial crisis in late 2008. Moreover, the systemic risk posed by the sovereign debt problems of the PIGS is even less today that it was in early summer. 


This chart of the euro vs. the dollar suggests that the euro is far from being on the verge of disintegrating. Indeed, the euro is doing pretty well relative to the dollar, and is not too far below its all-time high against the dollar. 


This chart shows that the yield on Greek short-term debt is elevated relative to German debt, but far less than it was last May. The bond market is thus telling us that there is a decent chance that Greece will default, but that is by no means a done deal, and even if Greece were to default, it would not likely bring down the core of Europe. German yields were much lower last summer when the market was very concerned that Greek contagion could result in a much weaker European economy. Today, German 2-yr yields are about twice the level of US yields, suggesting that the prospects for European growth are actually better than for the US. In that regard, I note that Germany's DAX index today is at a post-crisis high not seen since the second quarter of 2008; that's further support for the idea that Europe on balance is doing OK, despite the problems of the PIGS. 


As this chart shows, the yield on Irish 2-yr government bonds has dropped significantly in the past week or so, suggesting that the financial rescue package being put together for Ireland has substantially reduced its near-term default risk. The yield on 10-yr bonds has also fallen of late, but remains very elevated at just over 8%. That puts Irish bonds on a par with junk bonds, which on average are currently yielding 8.2%. Ireland is definitely a credit risk, but it is not a portent of great financial destruction or impending economic collapse.

7 comments:

Frozen in the North said...

Frankly, the problem of the PIIGS is really not a sovereign problem, its a banking problem. Europeans agencies don't want to face up to this reality. European banks are heavily exposed and would probably be insolvent if they had to take write offs on their loans. The UK banks have lend about E150 billion to Irish banks, and the German banks have done something similar. The reality is that both banking system rely on much higher leverage than we do in North America.

European country could declare bankruptcy (several will eventually) because the social unrest associated with the proposed cuts will lead to disintegration (I would be surprised if the Irish government survives the week).

Sure bankruptcy is painful , but its hardly the end of the world...

Public Library said...

Frozen, same goes for the rest of the levered world. If banks had to face up to reality the system would reset at a lower level across the board.

Eventually this will happen too. Printing money will not resolve solvency.

brodero said...

Remember GDP wise....Ireland = Nevada,Greece = Connecticut,Portugal = Kentucky....
BUT Spain = California

Buddy R Pacifico said...

Brodero, Italy=California, for seventh & eighth biggest econs in the world. Spain is #14. Italy may be next -- ambling up to the EU rescue window.

Benjamin said...

Good news, bad news. Commercial real estate going up in value, but still off more than 42 percent from highs...

New York, November 22, 2010 -- US commercial real estate prices as
measured by Moody's/REAL Commercial Property Price Indices (CPPI) increased 4.3% in September, its first increase since May and the largest gain in the history of the CPPI.

As of the end of September, prices are up 0.3% from a year ago but down 36.8% from two years ago. They are now 42.7% below the peak value reached in October 2007.

"Each of the summer months this year recorded declines in the 3%-4%
range, followed by this month's sizeable uptick," said Moody's Managing Director Nick Levidy. "The relatively large swings seen in the index
recently are due in part to the uncertain macroeconomic environment and the effects of a thin market with low transaction volumes."


I would say if real estate values are down 42 percent from highs, we still neeed a sustained recovery in that sector.

Steve Fulton said...

It's pretty easy to fix. Both Illinois and California will be doing at some point. It goes like this--remember we said you could retire at 55 and you'd get 75grand a year until you died? Well that's not gonna happen-sorry.

Public Library said...

Spain is going boom next. You might need to revisit the title of this post...