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Assessing the risk that Greece’s woes herald something far worse
Feb 18th 2010 | WASHINGTON, DC | From The Economist print edition
HOW far is it from Athens to America and which countries lie on the way? That may sound like an esoteric geography question, but it is being asked by investors as Greece’s debt crisis creates global jitters about the safety of sovereign debt. So far Portugal, Ireland and Spain, the other high-deficit countries on the periphery of the euro zone, are thought to be next in line. In most big rich economies, yields have been stable and well below their long-term average (see chart).
But nerves are fraying elsewhere. The cost of insuring against sovereign default has risen in 47 of the 50 countries for which these instruments exist. Dubai’s sovereign credit-default-swap spreads soared to their highest level in a year this week, amid concern about the terms of a debt restructuring by a state-owned conglomerate. There is increasingly shrill commentary arguing that Greece is the start of a far bigger problem. “A Greek crisis is coming to America”, blared the headline on a recent Financial Times article by Niall Ferguson, a financial historian.
The stakes are high. A sudden loss of confidence in all sovereign debt, and especially in American Treasuries, the world’s benchmark “risk-free” asset, would have calamitous consequences in a still-fragile recovery. Equally, an exaggerated fear of sovereign risk could prompt governments into premature fiscal austerity, which might itself push the world economy back into recession.
Neither the shrill nor the sanguine arguments can be dismissed out of hand. Fiscal pessimists point both to past experience and to the arithmetic of public debt for evidence that sovereign-debt crises could spread far beyond Greece. The lesson of history, as documented in a magisterial study of financial crises by Carmen Reinhart and Ken Rogoff, is that public debt tends to soar after financial crises, rising by an average of 86% in real terms. Sovereign defaults have often followed.
The arithmetic argument for pessimism is equally compelling. Virtually no rich country has a “sustainable” debt position, in the narrow sense that none is running a tight enough budget or is growing quickly enough to stop its debt burden from rising. The worst offenders on this count are the euro area’s peripheral economies, as well as Britain and America.
Greece stands out for the size of its debt stock, the scale of its budget deficit and the grimness of its growth prospects given high domestic costs and an inability to devalue. Worries about where growth will come from are the main reason why fears have, so far, focused on the other weak members of the euro zone (although Spain attracted decent demand for a 15-year bond sale on February 17th).
America and Britain, having their own currencies, are in a different position. But they are not immune to concerns about growth and debt dynamics. On February 18th Britain reported a deficit for January, a month of surplus since records began in 1993. Pessimists also fret about the sheer scale of America’s public borrowing and, especially, China’s role in funding it. News that foreign demand for Treasuries fell sharply in December and that Beijing was a big seller has fanned their concerns.
Nonsense, says the sanguine camp, whose members include Paul Krugman, a prominent New York Times columnist. In their view, those who fear a sudden rise in sovereign risk, particularly for America, misunderstand the reasons for the build-up of sovereign debt and underestimate the role of Treasuries as a safe haven. Sovereign-bond yields are low because private demand for capital is weak. And it is likely to stay that way as Anglo-Saxon households rebuild their savings and firms hold back from investing. (…)