Default is inevitable. Discuss.

Scofflaw wrote: »

I cannot see either how we could be kicked out, or even why we would be. I'd appreciate someone who believes the "in 2013 we'll be thrown to the wolves" soundbite filling in my evident ignorance about mechanisms and motives!

cordially,
Scofflaw

For the why ... motives are a more balanced strong central Europe and the more flaky periphery. I don't know the legality of how it would be achieved, but I am sure there are ways and means. We are not exactly keeping our budget deficit under 3% of GDP .... there's an excuse.

In reality the potential ultimate size of this crisis really means that all bets are off. Also factor in the real possibility of oil going to $200 per barrel in the next 2-3 years and you see it is extremely difficult to predict the future. I am not saying it WILL happen, but it quite possibly COULD happen.

Can the euro survive?

Julian Pendock

Eurosceptics point, correctly, to the fact that "one size does not fit all" when it comes to interest rates. These were set by the European Central Bank (ECB) for the benefit of low-inflation Germany, which – in the early days of the euro – was going through its own deflationary restructuring process. While rates of 3% might have suited the Germans, they were woefully low for the periphery countries – in fact, in many cases rates were negative after taking local inflation into account. For example, Spanish interest rates fell from 12.7% in 1993 to 3.0% in 2005, while Ireland's fell from 10.5% in 1993 to 3.0% in 2005. This was known as the "convergence trade", as interest rates converged with those on German bunds.

Ireland, with its low corporation tax rate of 12.5% and an English-speaking workforce, boomed in the 1990s with good reason. But fuelled by low interest rates, housing turned into a bubble. Irish banks' assets peaked at an amazing 629% of Irish GDP in 2008. You cannot solely blame the euro for this and other countries' problems. I lived and worked through the Asian crisis; poor banking regulation and overexuberant lending in those countries was down to extravagance, lax regulation and crony capitalism.

However, while many have accused peripheral countries of some or all of these lapses, the euro made all these failings worse through its flawed structure – a single interest rate for all, and no mechanism for supporting ailing members via fiscal transfers from other member states (unlike in the US). This is where the whole story becomes ironic. The euro was designed like this – with no bail-out mechanism and no exit route – so as to keep countries on the 'straight and narrow'. The situation that these countries find themselves in was designed to be ruinous in order to prevent them falling into it in the first place!

If they can't devalue their way out of trouble, the only path open to the troubled countries is a painful internal devaluation. This is where economics meets politics, which investors ignore at their peril. First of all, there is the issue of "bail-out fatigue". The German chancellor, Angela Merkel, should be riding high in the polls. Germany's economy has fared remarkably well as their supply-side reforms have paid off handsomely. Secondly, the euro is much weaker than a stand-alone deutschmark would be, to the great benefit of Germany's mighty exporters. However, Merkel's CDU party is suffering in the polls as German citizens, already exhausted from bailing out east Germany, are livid at having to bail out Greece, where the retirement age is considerably lower than that in Germany.

Yet a more immediate worry is 'austerity fatigue'. Austerity is not a one-shot deal, but a long, drawn-out process. The danger is that after several rounds of cuts, and with no light at the end of the tunnel, opposition politicians have an easy sell to weary and dispirited nations. They can argue that the country is spending more on servicing debt owned largely by foreigners than the countries are spending on education and health services.

In Ireland, the Greens have already left the coalition and are calling for a fresh general election. The EU believes this is not "particularly helpful". But the EU's attempt to prevent sovereign nations from having general elections is understandably being met with incredulity. An early insight into the political mood music can be gleaned from the fact that, according to professor Morgan Kelly at University College Dublin, the ECB oversight team in Dublin is known locally as "The Germans". Hence the paradox is that the nations funding the bail-outs, in order to sell the bail-outs to their own voters, may impose austerity terms that are too onerous for recipient nations to stomach politically. Certainly, there is a growing feeling that Ireland should have let its banks fail. In Portugal, a general strike suggests the same dynamics are emerging.

One must not forget what is at stake. French and German banks' exposure to PIIGS amount to €493bn and €463bn respectively, according to figures from the Bank for International Settlements. So it is in neither of those countries' interests to allow the PIIGS to leave the euro. For the time being, the direct costs of a bail-out (€170bn, assuming write-offs of 8% of periphery GDP), are less than those of breaking up the euro, given this massive exposure that the northern European banks have to the PIIGS. But should Spain be targeted next by bond vigilantes, all bets are off. The EU will not have the financial wherewithal to contain the crisis, the IMF would have to be called in, and the future of the EU in its current guise would be in doubt.

http://www.moneyweek.com/investments/currencies-eurozone-debt-last-rites-for-the-euro-51406

professore wrote: »

For the why ... motives are a more balanced strong central Europe and the more flaky periphery. I don't know the legality of how it would be achieved, but I am sure there are ways and means. We are not exactly keeping our budget deficit under 3% of GDP .... there's an excuse.

There aren't, it would require treaty change, which would mean a referendum in Ireland and possibly elsewhere.

Just back to an Irish default, interesting to see how CDS has moved recently. Figures from 1430 today Thursday.

NAME|LEVEL|CHANGE|
Portugal|541 (-14)|-2.6%|
Italy|124 (-7)|-5.6%|
Ireland|506 (-25)|-4.7%|
Greece|999 (+8)|0.8%|
Spain|198 (-7)|-3.4%|

The above means that it now costs almost €1m euro to insure €10m euro of Greek bonds, €541,000 to insure against the same on Portuguese bonds, and Ireland is now back to €506,000 to insure against the equivalent.

I think that is the first time we've been back in third on periphery CDS since 2010.

CDS would generally be seen as a more reliable marker of perceived likelihood of a credit event on sovereign paper than bond yields.

Sand wrote: »

And once Irish sovereign debt is split away from its banking debt (via default) then its in a much better place than Portugal or Greece. So, ironically, the view on Irish sovereign debt may be presuming a default on the banking debt. Who knows, maybe those dumb foreigners are sophisticated enough to know the difference between a bank and a sovereign.

Maybe Ireland should have been sophisticated enough to make that distinction. The sovereign decision to carry the whole private debt show in order to demonstrate what great big balls he had was ultimately a demonstration in political egotism.

The decision never was and is not an inability of foreigners to distinguish between private and sovereign debt. There is zip that an investor can do if the state wishes to nationalise or effectively nationalise a bank. Rather, the decision was little more than the naïve enthusiasm of the state toward its own imagined strength and, ultimately, a display of reckless stupidity.

Although maybe you are just being sarcastic.