Thursday, April 21, 2011

Greece will default, the only question is by how much


With Greek 2-yr debt trading at a yield of 22%, and spreads to Germany at record highs, the question the market is grappling with is not whether Greece will default, but by how much. As the chart below shows (HT: Zero Hedge), long-dated Greek bonds are now selling for 50-60 cents on the dollar, suggesting the market is expecting a default/restructuring that effectively reduces the amount Greece owes by almost half. We've seen massive restructurings like this before (Argentina comes to mind) but despite the magnitudes involved, life goes on. When debt is wiped out or cut in half, lenders lose but borrowers gain, in a sense. It's a wealth transfer, but it doesn't necessarily reduce the world's output, which is what provides the foundation for all wealth and all cash flows. And not surprisingly, therefore, despite the near-certainty of a massive Greek restructuring, global stock markets remain very close to their recent highs, and swap spreads in the U.S. and Eurozone remain relatively low.

8 comments:

Charles said...

Greece is not the issue and has never been the issue. The issue is the solvency of the banks that hold this debt. So why would Greece, Portugal and Ireland play along with the game of hiding the pea? When they default, they will not be able to run primary deficits - that is, they will not be able to finance operations before interest payments by selling debt. They are better off for the moment playing along.

How weak are Europe's banks? What happens if they need rescued? What are the prospects for some kind of run on these banks and how will the global economy be affected?

Scott Grannis said...

I've addressed this point quite a few times. Euro swap spreads are showing no sign of a bank solvency problem. They are somewhat elevated, to be sure, but not to the degree that would indicate there is a banking crisis around the corner. US swap spreads are very low, suggesting that the sovereign solvency problem will not materially affect the US or the global economy.

Dr William J McKibbin said...

My analysis through this week is causing me to lose some sleep over what is appearing on my screens:

DOW: 36,000+ by 2020 or earlier
Gold: $4,500+ by 2020 or earlier

Stocks and gold are not supposed to move together, but this is what I see coming -- I am very confused by what I am witnessing -- a perfect economic storm is forming up right in front of my eyes.

PS: The massive global transfer of debt from the private to the public sector is central to today's dynamics -- nothing on this scale has ever occurred -- the fiscal future of some governments appears particularly gloomy, especially the US, UK, Greece, Portugal, Spain, and certain states in the US, including California and New York, which have GDP's larger than the countries I just mentioned.

PPS: A private sector de facto adoption of precious metals and/or other commodities as a treasury basis appears imminent...

William said...

Worth reading over this long weekend:
The Fiscal Times: "David Stockman: Shutdown Deal Is Flimflam and Swindle"

http://www.thefiscaltimes.com/Columns/2011/04/14/Stockman-Shutdown-Deal-Is-Flimflam-and-Swindle.aspx

randy said...

Dr. McKibbin,

I'm curious what you mean in your PPS. I understand financial assets are losing ground to physical assets, but what do you mean by treasury basis.

Dr William J McKibbin said...

Hi Randy, my observation is that corporations are holding large dollar reserves precisely at a time when cash (including Treasury notes) are losing value globally. The financial analyst in me sees such circumstances as ripe for aggressive stock repurchases, which are happening. However, cash reserves are still required, and if reserves held in Treasury paper are losing vast amounts of value, then the only other alternative is bullion reserves. However, metals are historically volatile, so I am not certain about such a move as this. My question is this: What are companies going to do with their cash if the dollar continues to decline in value against other global currencies (?). Such treasury losses are only acceptable to a point. Currency risk is expanding...

Jeff said...

Is it just a coincidence that the largest holder of gold is also the largest borrower of paper money??

Since we are no longer on a gold standard, the Federal government doesn't have to confiscate gold (like 1933) to revalue the dollar. It can just borrow, spend, print and tax...leaving everyone who holds dollars with less in there pocket.

I agree with the good Doctor. We are seeing something scary developing right before our eyes.

TradingStrategyLetter - Weekly Summary said...

Forget Greece. Spain is the story. Almost 20% unemployment. Definately 'Too Big to Bail!'
If Spain goes down for the count expect Credit Crisis II - a nasty replay!