sovereign risk and the current economy

November 3, 2008 4:37 AM

Another economic post. With the debt and equity markets in a comparative calm, a lot of people are asking what next? One area little examined is the idea of sovereign risk. Basically, those with the armies make to rules, and you don't want to be invested there when they change the rules,. The USA has been the power behind globalisation for over half a century, enforcing the rules of the marketplace we have grown to accept. Some are questioning whether it can maintain this position.

Many countries have used their power to set the law to default on external debt, or in some cases, nationalise external investments. It is the last resort when your economy is in trouble, and a growing number of people see it on the cards for the USA (admittedly, with not much credibility). But who will be next?

posted by bystander (15 comments total)

Didn't work out too well for Iceland. (I guess they don't really have much of an Army, though)
posted by delmoi at 5:30 AM on November 3, 2008

People still ran to treasuries when they wanted zero risk.
posted by smackfu at 5:36 AM on November 3, 2008

According to the FT, Denmark is contemplating joining the € at high speed (it, like the UK, has an opt-out). The article lists countries that are at risk and which might run for the Euro as a safety net: Denmark, Iceland, Switzerland, Sweden and to a lesser extent the UK.

"Apart from lower interest rates, eurozone membership offers a joint policy framework and protection from speculative attacks. In good times, few people care, but these are not good times. The crisis will ultimately produce stronger economic governance. It will also make the eurozone larger, sooner."
posted by athenian at 5:44 AM on November 3, 2008

Barring Slovakia and Slovenia, all the eastern European countries that joined the EU in recent years were slow to prepare for monetary union, with disastrous consequences for Hungary in particular. Now painfully exposed as outside of ECB protection, many are changing their tune, and fast.
posted by e-state 4.0 at 6:04 AM on November 3, 2008

This makes sense. So the big winner from this may be the EU (as in the body, not necessarily the individual states). More states in the Euro means that the business cycles across the EU will harmonise somewhat due to monetary policy, and cross border trade becomes freer due to lack of currency risk. It's already almost impossible to withdraw completely from the EU because of business disruption, and this crisis has both vindicated and empowered the ECB.

As a pro-European, I like this.
posted by jaduncan at 6:08 AM on November 3, 2008

What do you mean "in the cards for the USA"? We already invaded Iraq, which has massive reserves of oil. If in 2001 the administration had realistic forecasts putting the price of oil at over 6 times its current price, then invading an oil rich country looks almost like a rational choice. This of course assumes that the invasion itself did not cause the rise in oil prices, a not necessarily accurate assumption.

The looming problem is deflation. If there is deflation, it means attempts to inflate the economy are failing. That means financing the massive government debt because an almost insurmountable problem, becasue the debt isn't inflating along with everything else.

On a more micro level, deflation means that any debt you personally carry are going to devastate your finances. If you have debt, you should be actively, and aggressively, eliminating it. It's one thing to be laid off, it's another thing to be laid off and owe people money.
posted by Pastabagel at 6:12 AM on November 3, 2008 [1 favorite has favorites]

"That means financing the massive government debt because an almost insurmountable " should be "That means financing the massive government debt becomes an almost insurmountable..."
posted by Pastabagel at 6:14 AM on November 3, 2008

Oh, how annoyed I get at 20th cenytury historians! The first globalization began in 1914? (from the "questioning" link)

The first globalization began in 1492! Or earlier, as the Portuguese began trading with West Africa. Or maybe the Silk Road...

The entire history of humanity has been one of growth and increasing density of networks (with fits and starts, and not linear, of course). I think 1492 is probably just about one of the most important dates, a real change in epoch, because that was the introduction of the Americas into a world network, but also because it is the most symbolic date of a an entirely period of rapid expansion in trade networks.

I really wish I could force every 20th century historian to teach a yearly class in history which is, you know, actually historical, and get them to realise that no, the world did not pop into existence with the light bulb. And our modern world did not erupt from the 19th or 20th century, but from movements and changes as much influenced by economic policy under Elizabeth I or the effect of flooding in the 16th century Netherlands, or the freaking Black Death.

(apologies to all 20oth century historians who do have a sense of the long duree - I'm just reacting to some recent personal experiences with ridiculous claims by smart but blind people, and it's boiling over.)

---------------------

Back to the actual point of the post: I need to finish reading the links, now that my anger has been a bit lanced.

But I have been thinking for a couple of weeks about how lucky the US is that its national debt is in American dollars. At least your debt will go down in value if your currency does, unlike what most other countries have experienced.
posted by jb at 7:00 AM on November 3, 2008

This is absolutely retarded. The US can't default on its own debts because its debts are denominated in its own currency. You just fire up the color copier.

Now that has repercussions, but not like default has.

Also look at a Debt/GDP table sometime.
posted by JPD at 7:37 AM on November 3, 2008

So... a while ago there was some talk that the price of CDS on US debt had gone up. I googled this but couldn't get much information. Is this seriously something you can buy? There exists a company that is taking money to pay out on the default of the US? That seems crazy, like who would you trust to pay you in a world where the US defaulted? (You can trust me, P.O. Box...)
posted by Wood at 8:28 AM on November 3, 2008

Wood - here is a recent link on the cost of US Treasury CDS. They are more expensive, but still pretty cheap compared to CDS on other types of bonds. And yes, if the US defaults you will probably have other problems beyond collecting on your CDS.
posted by procrastination at 10:02 AM on November 3, 2008

I still don't understand why you would buy a risky bond realize it's too risky for your blood and then get insurance. Why not just buy less of the risky bond and more t-bills? It feels like these guys are playing a shell game with risk. And/or "regulatory capitol relief not risk management" (from AIG's SEC filing.)
posted by Wood at 12:41 PM on November 3, 2008

Inefficiencies in the market could cause a risky bond + insurance to be a better investment.
posted by smackfu at 12:50 PM on November 3, 2008

Seems to me, the fact that a risky bond + CDS is or was significantly cheaper than simply purchasing a less-risky bond shows that the CDS "insurance" was probably underpriced. That seems like it ought to be a warning sign about buying CDSs in the first place, since it suggests that the company offering the insurance-like product isn't doing a good job of underwriting.

If I was shopping around for car insurance and somebody offered me a $100k policy for $5 a month I'd be pretty suspicious, too; nobody who underprices risk that badly can stay solvent for very long.

Frankly it stuns me that CDSs weren't (and as far as I can tell, there doesn't seem to be much interest in getting them) regulated as actual insurance products, and force them to only be sold by actual, regulated insurance companies. They certainly walk like insurance and quack like insurance; maybe we should start treating them like insurance.

Of course, hindsight is always 20/20, but I can't help thinking that if we'd treated CDSs as insurance products all along, that the situation wouldn't be nearly as dire as it is right now.
posted by Kadin2048 at 3:52 PM on November 3, 2008

Interesting Kadin, I was going to say something about car insurance before I read your comment. What if you bought a car with a loan and your lender required you to have comphrehensive insurance? Maybe you'd go get that suspiciously cheap insurance after all, since you're actually insuring someone else's money.
posted by Wood at 4:04 PM on November 3, 2008