Saturday, January 22, 2011

Swift Action Required

This story appeared in the NY Times a couple of days ago, reporting on the possibility of  buy-backs for deeply discounted Greek Government Bonds (GGBs) in the secondary market by the European financial stability fund (EFSF).  The particular story - there are many more like it in the financial press - was brought to my attention by Okie (hat tip), a longtime reader who wondered if I had something to do with it. 

Well, no and yes.  No, I didn't write the story nor did I campaign actively from the "inside" for implementation of the buy-backs.  But, yes, I believe I was the first one to come up with the idea;  it was published in this blog on November 23 under the title How To Restructure PIGS Debt - A Modest Proposal.  Please read it if you feel like it.

Another reader wondered if I had a priori knowledge of these developments, i.e. if I possessed inside information.  Absolutely not - but I do have extensive knowledge and practical experience involving sovereign debt markets and derivatives, allowing me to recognize opportunity when it arises.  Couple that with a solid dose of common sense and, voila, A Modest Proposal.

No one, however, commented on the  (perhaps not so obvious) reference to Jonathan Swift contained in the original post's title.  A Modest Proposal was published anonymously in 1729 by the renowned Anglo-Irish satirist and in it he proposed that impoverished Irish farmers should fatten up their children and sell them as meat to the well-off gentlemen and ladies of the land.  His essay went to great detail, including statistics, economic benefit calculations, quotations from (fictional) presumed authorities - even recipes!

My post was not meant to be satirical in the least, of course.  However, the chance to allude to rich Europeans eating their own poor children as a solution, instead of firmly helping them overcome their difficulties, was too good to pass up.  And make no mistake, there were and still are many addle-brained idiots (I use the word in its classical meaning) in Europe who see the debt issue from a  destructive self-centered perspective. 
Nevertheless, the market is starting to smell that a more comprehensive solution is in the works.  Though still at lofty levels compared to a year ago, prices for credit default swaps on GGBs have come down considerably in the past week (see chart below, click to enlarge).
5-Year CDS On Greek Government Debt

My prediction for the European debt crisis is that it will involve a long process of adjustment and real economic convergence amongst the partner nations.  Unlike the 1990's, when countries who wished to enter the eurozone focused on meeting numerical targets laid down by the Maastricht Treaty, Europe today has no alternative  but to become more cohesive, more integrated, more co-equal, to use a fashionable term, itself alluding to the pigs of another famous essay.

It won't be easy, it won't be smooth, it won't be pretty.  But it will happen and it will succeed.


  1. Right you are. That original post (A Modest Proposal) came to my mind when I saw that story in the New York Times and at Calculated Risk. I thought "that is too much of a coincidence."

    I thought either a) you are involved in these decisions; or b) you are highly influential and read by "movers and shakers." Among your past regular readers and commenters, London Banker comes to mind. (And I see he is writing again. Hmm, looks like I will need to catch up.)

    So, I put two and two together and figured that the people who make these decision either know you or read your post for the idea.

    It's a small world after all.

  2. Well, Okie, you are right on some counts. And you are definitely right about "it's a small world". When it comes to sovereign finance, it's a VERY small world and coincidences, well, they aren't coincidences.

    However, the decisions in this instance are not being made by financiers but by politicians - and that's an entirely different kettle of fish. Pretty small and unsophisticated fish these days, unfortunately, by comparison to the not so distant past.

    In the US we are accustomed to the easy movement between the business world and the executive branch of government. That's definitely not so in Europe, where businessmen are largely viewed with heightened suspicion.

    I'm no politician.

  3. I wondered about this some time ago, but I was thinking about it from the position of the United States.

    What would happen if interest rates spiked and the U.S. simply printed money to buy back it's own debt at a discount rather than default because it was unable to pay the interest?

    Isn't Japan going to have a problem paying the interest on its debt sometime in the relatively near future? And that's without an interest rate spike.

    I'm more interested in the big fish, the U.S./Japan than I am about Greece. Greece is a sideshow.

  4. To Hellasious or any other reader of Sudden Debt:

    Many people online are talking about the effects of QE2 on the price of food in the developing or under-developed world. Is there a connection? Could you explain or lead me to a source that could explain the cause and effect of QE2 on food prices?


  5. re: QE and food prices

    1. QE increases the money supply of dollars.
    2. More money means (by definition) inflation.
    3. The US dollar is (still) the global reserve currency and the currency used for most - if not all - commodity trading.


    HOWEVER... To some undefined extent QE is merely replacing money that was destroyed via debt default. No one is sure how much of the QE money is truly incremental and thus truly inflationary, in the monetary supply sense.

    But in the end it doesn't really matter... if people BELIEVE that QE is inflationary then commodity markets will rise. Quantum finance...

  6. Although, I have noticed that for the last couple of days that commodity prices have turned sharply lower....

  7. Thanks Hellasious. So instead of the Chinese purchasing bonds (using their spare cash) the Fed is doing the "purchase" with newly created cash? "Money for nothing and chicks for free."

    The steps of money creation are simple. But to me, not being involved in finance (and maybe a dummy), can get complicated.

    Reminds me of our chemistry professor explaining to us his first experience with a new concept for a chemistry class. It was chemistry for non-science majors, a promise of a simplified class, with no math.

    The first day of class the teacher is at the board describing the basic components of an atom: "This is the nucleus, it is comprised of a neutron and a proton. Spinning around the nucleus is an electron. The neutron has a charge of 0, the proton has a charge of 1, and the electron has a charge of -1."

    A student raises his hand and complains, "I thought you said this class wasn't going to have any math."