Sovereign Debt and the Markets
Feb 9, 2010
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.
