Wednesday, May 5, 2010

The silver lining to the Greek crisis

Here's how the bond market sees the action in the eurozone financial markets. Yields on 2-yr Greek government debt have spiked to 15% or so, indicating the market sees a high probability of some sort of Greek default or restructuring. Not a total default, but at least a partial default; prices on Greek government bonds range from $84 for the 2-yr, to $76 for the 10-yr, to $60 for the 30-yr. So maybe the market is priced to something like a 20-25% haircut. Meanwhile, yields on German bonds have dropped, suggesting that investors see Germany as a safe haven, and/or investors see a Greek default spilling over into weaker European growth prospects.

This next chart shows how the U.S. bond market is reacting to the distress in Europe. Bottom line: it's not a big deal. Bond yields are down a bit, but not by enough to suggest any major deterioration in U.S. growth prospects. The market for some time now has been worried that the U.S. economy won't enjoy strong growth, and distress in Europe simply reinforces those concerns.

Here's how the stock market is reacting. Equity prices aren't down much at all, but implied volatility has spiked quite a bit. That suggests the market is more worried about the uncertainty of the Greek threat than it is about the threat it poses to growth. Previous spikes in the Vix saw much greater declines in equity prices than we have seen in the current episode. Perhaps this also suggests that the market has been captured by speculative fever—hedge funds looking for the next big killing are piling on to the Greek default story and its many possible "contagions." Might the euro get killed? Might global growth be derailed? Which country is next in line to default?

The euro has lost a little over 10% of its value against the dollar since January, and the dollar is up about 10% against a basket of currencies over the same period. This suggests that those worried about the situation in Europe see the U.S. as a safe haven—a refuge against contagion in Europe and the possibility that the euro itself could be at some risk. But looking at things from a long-term perspective, the dollar is still relatively weak and the euro is still relatively strong. So pricing has not yet even remotely reached crisis proportions.

I keep thinking this is a tempest in a teapot. Even if Greece defaults or restructures its debt, that is no reason for the euro to be dissolved, or for European growth prospects to collapse. Call me an eternal optimist, but this "crisis" has a bright silver lining, since it focuses the world's attention on one of the biggest problems faced by all major economies these days: bloated government. This issue is playing big in local elections all over the country; the Tea Party owes its very existence to this issue. The bond market, by refusing to buy Greek debt, is exerting powerful discipline on the Greek government.

What is so scary about cutting government spending? The only ones who will suffer will be the government workers that have been enjoying rising salaries, supremely generous pension and retirement benefits, and job security. The private sector has been putting up with far worse for a long time. Those who fear that cutting government spending will plunge economies into recession and deflation are the ones who don't understand that government spending is not stimulative in the first place. Big and growing government only weakens economies; so it stands to reason that cutting back on government should boost economies.

Rather than fear the deflationary consequences of slashing Greek government spending and freezing government salaries, it makes much more sense to cheer the end of big government. Less government means more freedom for the private sector; less spending means smaller deficits; smaller deficits leave more money for the private sector to put to more productive use; the return of fiscal discipline is a huge boost to confidence. The benefits of fixing the problem of bloated government surely far outweigh the costs!


septizoniom said...

bad is always no big deal; good is v. hahaha.

John said...


I had really hoped you had decided to take your ridicule over to SA.

I truly cannot imagine a more worthless comment.


Great post. Those wanting to successfully employ some capital should read and reread this.

septizoniom said...

john: are you scott?

John said...


No. But that's the first post I've seen from you that is complimentary.

See? It really isn't hard.

Unknown said...

Those who fear that cutting government spending will plunge economies into recession and deflation are the ones who don't understand that government spending is not stimulative in the first place.

How can you say that when in the States the only reason of the recovery is the huge gvt spending? Do you think for 1 sec that without all this spending and tax breaks the US economy would be where it is now? absolutly not...

In the long run I agree that too much gvt spending is not good as it tends to be a waste of money but cutting spending on that scale will certainly damage the economy even further...

Anonymous said...

If you think a 23% sales tax is a cut in government spending - sorry Scott. According to S&P´s there will be no growth in Greece until 2018. retail sales are down (department stores -15%). If you are interested in greece, try
Edward Hughs (economist) Blog.

brodero said...

How about this....

Moody's Baa yield a week ago 6.21%


tom said...

Those who fear that cutting government spending will plunge economies into recession and deflation are the ones who don't understand that government spending is not stimulative in the first place

I thought this was a great comment. If only the MSM would latch onto this idea rather than mindlessly tout the opposite.

Great post!

Public Library said...

Somehow you are under the illusion Greece is isolated in its egregious banking practices and the impact will remain isolated to that silly profligate spending country.

In reality, we are in the 3rd or 4th inning of a global solvency crisis. It was only a matter of time before the weight of debt cracked open a few levies.

Amazingly, everyone here believes you can issue more debt and print more currency to escape a solvency crisis. With the only pain being a bit of dollar depreciation and a few unemployed.

John said...


You should do some S&P puts or something. If you are so sure the world as we know it is ending, man up and put some cash on the line.

Otherwise you are just being chicken little.

Public Library said...


Keep your cheap shots within your other cheap conversations.

If tail risk hedging was cheap enough for the little guy, I would do it all day, month, year, decade long.

Having said that, my portfolio is very conservative my friend so I am not the last bit worried.

John said...


That's one of the best comebacks I've seen! Good job.

Seriously, if you feel that strongly, look into using options. Risk is limited and you can position for as long as a couple of years. AND, you could be right. If you are, you could do VERY well with not a lot of upfront risk.

Just something to think about.

Public Library said...


It's too expensive to maintain on small portfolios.

Someone should devise a tail-risk ETF! Then offer double and triple levered tail-risk ETF's!!!

Ha ha

Public Library said...
This comment has been removed by the author.
Unknown said...

I don't know the Greece public sector salaries but here in Poland there are very low comparing to private sector, so this is different than in US. I see no space for lowering them here.

Steve Fulton said...

It seems to me that the euro has been at least part of the culprit behind Greece's current debt (not liquidity) problems. I don't understand why it makes sense for anyone for Greece to borrow euros at 15% (or 10 or 8 or whatever rate that is clearly higher than their growth possibilities) to finance, among other things, a trade deficit, with Germany.

Unknown said...

And after a long weekend the Big Others decided that we (non EUM members) have to pay for this 10 years long export to PIIGS driven Germany prosperity.

Race Equality Secret Service said...

The Melanochroi Greek Crisis is caused by Racism.

BNP (Black National Party)

The BNP (Black National Party) has been created to expedite the work of the Race Equality Secret Service (RESS).

The BNP (Black National Party) gets stronger as "STORMFRONT" gets weaker.