Playing Devil’s Advocate with Dr. Don (For a Minute)…

This week, one of my friends on Twitter, Dr. Donald van Deventer posted this link in a tweet:

It’s an article by Luke Baker, Reuters’ foreign correspondent in Brussels. I told him I was going to take the other side of some the things stated in the article, and this post is my way of making good on the commitment.

I don’t disagree with everything Baker says in it, actually. He makes some valid points. For example:

The yield on 10-year Greek government bonds over dependable German Bunds (the spread) rose to more than 400 basis points — a euro-era record — at one point last week, meaning Greece had to offer a 4-percentage-point premium over Germany to entice people to buy its debt, offering a yield of more than 7 percent. That obviously increases its debt financing costs and leaves it even more in a fiscal hole than it needs to be at a time when it’s trying to raise more than 50 billion euros to finance the budget — and when finances are already under pressure following the economic crisis.

Yes, we’ve seen a blow-out in spreads of Greek debt to the German bund. And yes, we might think 400 bps is too high, since Greece’s economy is a developed one as opposed to a developing/emerging one. But to complain about its debt servicing burden while it’s being beaten down? Well, that’s just the way it is. The strong are rewarded with cheap funding costs while the weak have to prove they can handle the high funding costs they’ve been dealt. So Papandreou has to prove he can play with the short stack while Merkel has a commanding chip lead. Sorry. Play your way and earn chips or go bust. It’s that simple.

But the lion’s share of my disagreement is here:

But when it comes to absolute risk — the real possibility of Greece defaulting on its debt — it’s questionable that Greece is really as much of a liability as that. Not only is it a developed, European sovereign debt issuer, but it shares a currency with 15 other countries in the euro zone. Their stability depends greatly on Greece’s stability and so in effect it has 15 backers — call them lenders of last resort if you like – standing by ready to help out if things really get to breaking point.

See, I think he has it wrong. The EMU is nowhere near as symbiotic a framework as Baker thinks or suggests. Now I’m going to use one of my posts to show you how I believe the system really works:

So the Greeks can’t conduct monetary policy on their own, and fiscal policy has been largely handed over to others as well because they have to adopt inflation policies and government spending policies across the Euro-zone for the privilege of using the Euro and piggy-backing off of France & Germany’s credit ratings.

So, you can see what dynamic I think is at work: the rest of the continent is piggybacking off of Germany and to a lesser extent, France. While Spain’s economy is relatively large to others on the continent, Germany is the country that “moves the pile.” As such, I don’t think Greece has 15 backers. If Germany decides they want to bring back the Mark, most of the continent is screwed because the benefits of Germany’s fiscal and monetary discipline that the continent enjoyed will be gone. Those benefits will be once again reflected in the Mark – not the Euro.

Papandreou’s talk about speculators and CDS? I have two reactions: 1) Tell that to Jimmy Cayne, John Meriwether, Dick Fuld, and Jeff Skilling. If the market senses you can be taken down, they’ll try to do it. That won’t change. The solution? Don’t put yourself in that position in the first place. 2) As Tim Backshall points out, it’s not CDS that’s driving this crazy train, but the cash bonds. The CDS spread is actually tighter (i.e. less risk) than the cash bond spread to the Bund.

And since it’s Friday night and I’m thinking of crazy trains, I’m going to close this post with this: Ozzy frickin’ Osbourne’s “Crazy Train.” Seems to be pretty apropos for the credit and currency markets these days…


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Filed under finance, government, International, macro, Markets, Way Forward

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