Graphic: A History of Sovereign Defaults

Just a reminder that there is no such thing as “risk free”, particularly on the popular impression that government debts are safe havens.

Below a historical roster of Sovereign debt defaults from Wikipedia.org

Africa:

Americas:

Even the US has had several instances of defaults.

John Chamberlain at the Mises Institutes explains some of in list: Continental Currency Default of 1779, Default on Continental Domestic Loans, Greenback Default of 1862, Continental Currency Default of 1779, Momentary Default of 1979

Asia:

Postbellum Japan has not been spared too.

So as with the Philippines whom restructured debt in 1983/1986 (World Bank)

Europe’s largest economies Germany, the United Kingdom, France has had their share of defaults or partial defaults (restructuring)

As per historian Edward Chancellor (also cited by the wikipedia.org) reasons for default consist of: A reversal of global capital flows, Unwise lending, Fraudulent lending, Excessive foreign debts, A poor credit history, Unproductive lending, Rollover risk, Weak revenues, Rising interest rates, Terminal debt.

All these are rather symptoms of political spending which has been unproductive and consumption based (e.g. welfare, wars, bailouts, bureaucracy, etc.) and which frequently leads to excesses.

The idea that government debt represents as safe haven is no less than political travesty meant to justify the current unsustainable debt based political economic institutions. 

Eventually, the naked will be exposed when the tide subsides.

War on Speculators: Restricting Short Sales on Sovereign Debt and Equities

How does government resolve the problem of their profligacy? Well, blame the speculators (a.k.a. markets)!

From the Wall Street Journal

European Union finance ministers Tuesday reached an agreement on rules limiting short-selling of shares and sovereign debt, overcoming concern from the U.K. that the legislation will give the EU's new securities regulator too much power.

The ministers must now negotiate a final version of the legislation with lawmakers at the European Parliament, which favors broader rules that would also cover short sales of credit default swaps linked to sovereign debt.

France and Germany in particular have blamed short-selling of sovereign debt for having exacerbated the euro-zone debt crisis, though regulators say there is little evidence that trading activity has caused the yields of Greek, Irish and Portuguese bonds to soar in the past year.

These has been a continuing motion to pass the blame on everyone else in what truly represents as the unintended adverse consequences of past policies.

Global CDS Update: World Credit Stress Easing

Here's an update on the world Credit Default Swap (CDS) market from Bespoke Invest.

Based on the Feb 5 lows, as Bespoke observes, ``Portugal default risk is down the most at 40%, followed by Austria (-38%), and Spain (-32%). Vietnam, Argentina, and Egypt are the only countries that have seen default risk increase.

While most of the CDS have been significantly down from the early February anxiety, they are mostly up compared to the start of 2008 except for Lebanon and Kazakhstan.

Such easing of credit concerns adds to our "sweet spot" scenario.

Global Market Rout: One Market, Two Tales

Financial markets had reportedly been rattled by concerns over rising debt default risks.

As the chart from Bespoke Invest shows, US Credit Default Swaps (CDS) or the cost to insure US debt spiked as global markets swooned.

But it's a different tale when seen across the US yield curve: Treasury yields fell or bonds rallied!

If indeed the markets have been apprehensive about the default risks from government debts then US treasury yields should have risen as these would have come under strain. Fear of default translates to higher yields. But this didn't happen.

In short, bond markets have exuded inconsistent signals.

In my view, the markets seem to be enduring from the uncertainty brought up by conflicting indicators; where policymakers have generally turned hawkish, as they repeatedly or have been bombarding the press with talks of 'exit' strategies (or even experimenting on it as with the credit arm twisting tightening in China) amidst current markets conditions, whereby key financial markets have essentially been heavily dependent on government steroids, and by the state of sovereign overindebtedness, as a result of collective efforts to mount a rescue of respective national economies.

In other words, the markets appear to be violently responding to the prospects of policy (or liquidity) withdrawal and have used the debt default risks as an excuse for the recent actions. They maybe asking, without money printing who'd finance all these debts?

We may call this the withdrawal syndrome.

Here's our guess, continued pressure on the financial markets risks undoing the animal spirits and resurrect the specter of 'deflation', and thus, would prompt authorities to turn from hawkish to dovish.

Not All Aaa Credit Ratings Are Cut From The Same Cloth

Faced with today's financial hurricane, credit ratings agency Moody's announced how it ascertians risks conditions that may impact Aaa sovereign debt ratings of developed economies.

Researchrecap quotes Moody's, ``For a Aaa government to be downgraded, Moody’s must have concluded that the deterioration in credit metrics is (1) observable and material in absolute terms; (2) observable and material in relative terms; and (3) unlikely to be reversed in the near future,” Moody’s says. “The decision underlying a potential downgrade would also depend on the extent of the actual and potential deterioration of a government’s balance sheet; whether a country’s economic model can be regenerated, thereby allowing the economy to rebound; and whether governments can repair their fiscal position by raising taxes or cutting expenditure.”

graph from Moody's

So from the said conditions Moody's categorizes them into three groups:

1. Resistant Aaa countries, such as Germany, whose rating is so far largely untested despite strong headwinds;

my comment:

Germany, France, Austria and Switzerland are rated higher than the US or UK even if they are all Aaa.

2. Resilient Aaa countries, such as the UK and the US, whose ratings are being tested but, in our view, display sufficient capacity to grow out of their debt and repair the damage;

my comment:

Moody's is being too optimistic. Once the latest stimulus measures fail to achieve its objectives, we will probably see more of the same efforts.

And additional government resources thrown to resuscitate the economy may constrain strained economic resources which may eventually risk jeopardizing the present ratings standing.

Remember, during the credit bubble days, Moody's was instrumental in providing Aaa ratings to obscure structured finance products, which eventually turned out to be "toxic" and which remains a key burden to the banking system's seeming inextricable balance sheets.

3. Vulnerable Aaa countries (Ireland and, to a lesser extent, Spain) who face equally stern challenges and whose rating will depend on their ability to rapidly regenerate their economies. Indeed, in the case of Ireland, Moody’s placed its Aaa rating on negative outlook on 29 January 2009.

my comment:

Aaa ratings like ALL government guarantees are never risk free.

Besides, grading sovereign papers isn't entirely about finance or economics but likewise subject to political impediments or possibly conflict of interest issues.

Perhaps we will see some material downgrades among some of these Aaa sovereigns as the crisis reach maturity.

(Source Research Recap )

Sovereign Debts: Let the Downgrades Begin!

Making good its warning, the US credit rating agency Standard & Poor's downgraded the credit rating of Greece amidst a deteriorating economic environment and expanding debt.

According to the Wall Street Journal (bold highlight mine),

``The one-notch downgrade to A- comes as S&P has warned of ratings cuts for some of the European Union's weaker members. Spain and Ireland are also among those which have been threatened with downgrades.

``In Greece's case, S&P pointed to the need for "necessary reforms of public spending," noting the government's ability to improve its budget position through better tax collection and higher property or income taxes is offset by the rising cost of debt servicing and public pressure for additional social spending.

It’s not just Spain and Ireland under watch, but also Portugal.

Insuring sovereign debt via Credit Default Swaps (CDS) have been materially climbing for many developed countries. This reflects growing concerns about the possibility of countries to default. Yet as governments race to provide guarantees and stimulus support programs to cushion the impact of a downward spiral of their respective national economies, more economies may be put under the credit watch. See chart courtesy of FT Alphaville.

As we earlier dealt with in Sovereign Debt The New Ponzi Finance? and Government Guarantees And the US Dollar Standard, there is no free lunch.

Guarantees and all other government spending will have to come out of real resources or real capital.

As Richard M. Ebeling of American Institute for Economic Research wrote, ``Government deficit spending and the resulting debt is a burden on both current and future generations. Today’s deficits have to be paid for out of current production and output. Those who lend the money to the government forgo the private-sector uses for which that money could have been applied. Every dollar borrowed by the government means one less dollar that a private investor could have used to expand his business, or start up a new enterprise, or spend on research and development that would have introduced product innovations for the benefit of the consuming public.”

Nevertheless, with a barrage of proposed government spending (chart courtesy of Casey Research) intended to prop the US economy, the US risks endangering its AAA credit ratings status which at the same time jeopardize its currency reserve standings.

But bureaucrats remain confident of a government maneuvered turnaround.

Stay tuned.

Default Risk: The Philippines Ranks 12th

The following chart from Bespoke Investments exhibits the order of default risk among nations as determined by the cost of insuring the local sovereign debts via the Credit Default Swap (CDS).

According to Bespoke Investments ``These prices represent the cost per year to insure $10,000 of debt for five years. We also show what the prices were at the start of the year. Of the G-8 countries, Russia has by far the highest default risk with a CDS price of $523. That's higher than any of the struggling banks we highlighted yesterday. Japan, France, the US, and Germany have the lowest default risk of the group of countries, but they have all spiked more than 200% this year. Argentina is in the most trouble, with a cost of $4,453 per year to insure just $10,000 of debt. Venezuela is the second worst at $2,016, followed by Lebanon, Egypt and Indonesia." (highlight mine)

The Philippines is ranked 12th and is about 200 basis points away from Indonesia. However, looking at the start of the year figures, the Philippines rose by only 265 basis points compared to Indonesia's 485, while Malaysia and Thailand saw significant increases too but at less the pace than ours at 185 and 165 basis points, respectively. Although if seen from the perspective of % change from the start of the year, the Philippines would account for the least.

Yet we can't deny that by being the 12th, this means the CDS markets believe we are one of the more vulnerable countries in the heightened risk aversion landscape.