Tuesday, January 11, 2011

Portuguese recycling & Iceland recovery -- Why the Chinese and Japanese are buying EU debt

The recent news of both China and Japan buying EU debt provides a very interesting window into the various motivations of investors.  While most investors are leaving the PIIGS debt markets, China and Japan appear very willing to invest.  Why?  It appears the Asian nations' motivations are different than return of principal.  Both are exporting nations and if more European trading partners are forced into austerity measures of higher taxes and lower government spending their own export industries will suffer.

American policy makers should be mindful of this when negotiating with China. It may appear they have the upper hand when looking at their massive foreign exchange reserves, but China also needs our markets to keep their factories running.

Unfortunately Portugal looks to be the next domino to fall, Asian assistance notwithstanding.  FT's blog lays out the timeline I have previously alluded to: It appears once a PIIGS' bond yield pierces the 7% level a bailout eventually follows.

However even with these 'bailouts' and Euro Central Bank assistance the problem has not been solved. As austerity measures and budget cuts drag GDP down the burden of debt grows ever higher in a nasty feedback loop.
From Satyajit Das:
Cuts in government spending and higher taxes have mired the economy in recession. Falls in tax revenue necessitate increasingly deeper cuts in spending to try to stabilise public finances. In 2010, the budget deficit was forecast at 12% of GDP, even after spending cuts and tax rises worth Euro 14.5 billion   The problems of the banking sector are increasing due to the poor economic conditions. Hitherto largely confined to commercial property, problems are now spreading to the broader economy. Unemployment and lower incomes mean that householders are unable to meet payment obligations on mortgages and other loans. Weak economic conditions have affected businesses, increasing default levels. In the absence of strong economic growth, inflation and a massive devaluation, the peripheral economies, such as Ireland and Greece, may be unable to shrink themselves to solvency. A simple relationship demonstrates the unsustainable position:
Changes In Government Debt = Budget Deficit + [(Interest Rate – GDP Growth) X Debt]

In order to restore solvency, overburdened borrowers must stabilise debt and begin to reduce the level of borrowing. This requires GDP Growth exceeding interest rates, a budget surplus (through spending cuts and/or tax cuts) or a combination of these. EU/ IMF assistance to Ireland was designed to address the high yields on Irish bonds, which curtailed the State’s ability to borrow. But the 5.80% cost of the bailout debt requires an equivalent growth rate and a balanced budget simply to stabilise debt at current very high levels.

Meanwhile the recovery in Iceland provides contrast to the current austerity and higher tax drudgery in the weaker European countries:
The Nordic economy grew at 1.2pc in the third quarter and looks poised to rebound next year. It ends a gruelling slump caused largely by the "New Viking" antics of Landsbanki, Glitnir and Kaupthing, the trio of lenders that brought down Iceland's financial system in September 2008. . .
This has led to vastly different debt dynamics as they enter Year III of the drama. Iceland's budget deficit will be 6.3pc this year, and soon in surplus: Ireland's will be 12pc (32pc with bank bail-outs) and not much better next year . . . 
The pain has been distributed very differently. Irish unemployment has reached 14.1pc, and is still rising. Iceland's peaked at 9.7pc and has since fallen to 7.3pc.


  1. the can stops being kicked when the first senior bond holders are forced to take a haircut.the tide is not all the way out.

    it will happen....ask bernie m.

  2. Heh. Portugal was able to sell some debt today but the trend is not on their side. 2011 will be very interesting.

  3. really think the ECB can't push it to '12? all of this has consistently taken longer than i thought.

    bailouts n papering have been temporarily successful.ECB digging a hole,albeit temp. successful.....iceland took the banking "swedish model" (circa 1990) n its working...dow to 5000 but it might go thru 14k to get there.

    ultimately everyone sleeps with the swedish model.sounded good to me in '08.

  4. I doubt they can keep Portugal from getting a bailout by the end of this year.

    The Swedish model you allude to will involve a lot of pain and that is why the politicians don't want to do it, regardless of the long term benefits.

  5. i think they will borrow or print n bailout til the german people put a stop to it......i realize hamburg n paris very exposed to PIIGS debt.

    can't sell tomorrows pain but the day after's health n get elected in a 'now' society.

    i brush my teeth w/ 1 drp. of 100% oil of oregano--BURNS like the devil.......but my gums are tight at 2mm n dentist is mystified.

    no pain, no gain

    (dead-bang peridontal disease cure,by the way)


  6. You are most likely correct. Getting the timing right is the tricky part....