Archive for February, 2010
Sovereign Debt and the Markets
Posted by Jody Eisenman | Filed under Uncategorized
Over the weekend, I discussed the US debt situation. I will now get into what’s going on in Europe. Last November, the markets showed some instability over the Dubai World debt crisis. Now, it appears that several European Union countries, led by Greece, are facing a similar crisis. The ECU has a cap that permits members to take its yearly deficit to a maximum of 3% of that nations’ Gross Domestic Product (GDP). Greece is now looking at a number of 12.7%. In addition, their total debt is now slated to increase to a staggering 135% of GDP, according to EU estimates. Portugal is looking at 91% and Spain is looking at 74% by 2011. As the case with our country, these numbers are not only incredibly high, but could threaten the overall stability of the euro. Default is definitely a possibility in Greece, and there are fears this could spread to other ECU countries. When a country’s debt gets too high, they must either cut expenses or raise revenues via taxes. Needless to say, neither course is politically popular. Strikes have broken out in Greece over proposed wage reductions, and Greek bonds have been dumped by investors. Overall, as debt rises, rates should rise as well in order to compensate investors for the increased risk of lending. Of course, as rates increase, the amount the country must pay on its debt service increases as well. As the record US debt reaches historically high levels of GDP, that same fear exists here as well. The biggest fear is that the US will lose its’ coveted AAA rating.
I don’t see the US losing its’ AAA rating anytime soon. The US is still considered to be one of the safest, if not the safest country to invest in. However, as Lawrence Summers, (Obamas’ chief investment advisor) stated, “ How long can the worlds’ biggest borrower remain the worlds’ biggest power”? Will the US begin to lose influence in the world ala Japan in the last decade? It could happen. At the end of the day, you cannot live your means for an extended period of time. Sooner or later, it becomes time to pay the piper.
As a result of this potential crisis, US financial markets are beginning to weaken. The Dow lost almost 104 points today to close below 10,000 for the first time since last November. The selling intensified late in the day, as most of this loss happened in the last 30 minutes of trading. So far this year, we are down over 500 Dow points, and over 800 points since January 19. Bulls are saying that this is a natural correction since the huge runup last year off the March lows. However, Bears are pointing to the very real potential debt crisis, which could overshadow everything else. I remain cautious here, and I would not be in a hurry to buy until I see more positive signs.
Debt Crisis?
Posted by Jody Eisenman | Filed under Uncategorized
Much of the financial news this past week concerns the sovereign debt situations of several European countries, as well as the United States. As pretty much everyone knows, too much debt, whether it be by individuals, companies, municipalities or countries, can be devastating. The past 30 years has shown us several examples of this. Back in 1982, Mexico faced default on enormous debts to several US commercial banks. In the end, the IMF (International Monetary Fund) bailed out Mexico, thus saving the banks from potential devastating losses. In 1994, the crisis re-emerged, and they were again bailed out. In the late 1990s, many emerging nations such as Thailand, Indonesia, Brazil and Argentina faced a similar situation. Once again, the IMF stepped in to bail out most the countries. In 1998, Long Term Capital Management, a %6 billion hedge fund headed by John Meriwether, faced severe margin calls due to excessive leverage. In a controversial move, the Federal Reserve arranged a bailout, due to the belief that the unwinding of their positions in a less then orderly fashion could be harmful to the financial markets. Finally, in 2008-9, we saw the government bail out several whole industries, including the autos, the banks, and Fannie Mae and Freddie Mac.
Today, we are faced with a situation eerily familiar to the past. The difference is, the crisis is now with countries, and the countries include the largest industrial nations of the world. Early this week, President Obama introduced a new budget that will show a record deficit. Although the United States is considered one of the wealthiest nations on the planet, with a standard of living that can only be envied by most of the worlds’ population, we are in debt up to our eyeballs. In the last 30 years, the US debt has gone from $380 billion and 26% of GDP (Gross Domestic Product) to a projected $14.5 trillion in 2010 and 67% of GDP. These numbers are staggering, but what is more amazing is the fact that in any normal situation, the interest rate on our debt should be rising. In other words, lenders who buy our treasury bonds should be demanding higher yields to offset the risk of lending to a country with huge debt. In fact, this has not happened. Six month treasuries are yielding 17 basis points, or .17 per cent. One year paper is around 30 basis points. That means that an investor who buys a one million dollar one year treasury will get roughly $3000 in interest for the year, or $250 per month. Hardly seems worth it, does it? Why are rates so low? Lenders believe that the US represents low risk as we have not missed a payment in 200 years. Eventually, all debt must be repaid. Should lenders such as the Chinese ever get nervous enough to cut back on treasuries, it could spark a painful rise in rates. Tomorrow, I will analyze the European debt situation and the effect on the Wall Street.
