Global " recovery " mirrors in sovereign debt insurance costs

Cheeky Bastard's picture

Since the surge in sovereign CDS prices in the second half of 2008, which was triggered by the overall catastrophic future view on the global economy, the positive results experienced in the last seven months resulted in the prices to significantly drop for most of the industrialized economies. The only economy which experienced the increase in its debt insurance cost is Japan.

But the increase in the price of the Japanese CDS contracts (which was only 1.8% YTD) can be prescribed to the multi-decade lagging Japanese economy. The biggest drop was experienced by Russia with 77.8% YTD price decrease in its debt insurance. It is believed the sudden fall is a result of the measures undertaken by the Russian Central Bank and the increase in crude and natural gas prices, upon which the majority of Russian economy lays. Constant cuts in the interest rates resulted in credit expansion and the Bank stated recently it will cut the rates even lower if the general economic conditions require so.

Generality can be drawn, and we can easily say the trend is positive for the exporting nations. Given the massive QE done by the FED the drop is by itself a surprise. But, an even bigger surprise is the percentage number which denominates the drop. The sudden deterioration in the debt insurance prices has some of its reasons rooted in the monetary policies conducted by the FED and other Central Banks. By triggering inflation in the equity markets the Central Bank masqueraded the true economic picture which is not as optimistic as many think. While the housing prices are still on the downfall and the credit is not expanding for consumers and business, the miraculous 8 month run in the equities is obviously a good enough reason for the sudden reversal in CDS prices. Sectoral inflation FTW.

The more ridiculous example of the irrational nature of the international traders is the situation with Spain. The ailing economy of one of the biggest European nations experienced a 32% YTD decrease in its debt insurance costs. Given the situation in Spain is deteriorating day-by-day the only reasoning which can be used as an explanation for the sudden drop in its debt insurance costs is the interlocked nature of the global economy and the subsequent closed eye of the international financial community when it comes to evaluating the economies looking at their internal conditions.

The methodological fallacy of observing the general economic conditions will surely result in at least one sovereign default in the next 12-24 months. Which country will it be i can not say with a convincing certainty, but my focus is on Latvia, Hungary and Romania.

Also, I share no doubt in my mind that once when one of the nations mentioned above collapses under the weight of its irrational debt piling, and when the costs of credit insurance once again skyrocket to the post Lehman level, the IMF will step in and put the collapsed country on the path of servitude and obedience. 

As was shown by previous policies conducted by the IMF the countries which decide, or are forced to receive the help from the aforementioned institution, can expect gigantic cuts in every social program, privatized public sector, and the subsequent offering of the public assets to the Western corporations for pennies-on-the-dollar prices. And, after the first domino falls, crushing any hope in a recovery, the bailout game will start all over again, but on a much greater, opened scale.

And when some big sovereign default occurs the clueless pundits will, once again,be surprised and will lead their propaganda by advocating the usage of policies rooted in the theoretical fallacy which is Keynesianism. Excessive government spending has never and will never build a sustainable economic environment.

The data for the other nations is provided in the table below.



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Green Sharts's picture

Can Cheeky or somebody explain who writes CDS contracts on sovereign defaults and why the buyer has any confidence that they will ultimately be able to pay off in the event of a sovereign default?

AR's picture

In-house, it is becoming exceedingly difficult to find short-term cash denominated instruments in any currency which is not subjected to ongoing deterioration (and volatility) due to increasing debt levels (private, public, governmental). It's a serious problem. Good post CB.

lovejoy's picture

Thanks Cheeks. I have always wondered about soverign DEBT CDS, because in reality, a sovereign cannot default on debt, except when they hold the debt in a foreign currency or are confined by union such as the European Union. The sovereign central bank can print all the money it needs to pay off the debt. The only problem is that the currency may get killed and hyperinflation may occur. [Although Japan is interesting to watch. It's debt has gone through the roof, but its currency has become stronger and they are still experiencing deflation.] But if the sovereign has borrowed in its own currency, it can never default. Remember this and you earn money on the spread provided you hedge the currency. The problem in the past for all third world countries was that they held their debt in U.S.D., so they could never print enough money to make up for the depreciation of their currency relative to the U.S.D. In turn, Europe is a unique phenomenon. The central bankers of each country have lost the power to support their own economies. They are reliant on the EU central bank telling them what to do. That is why Spain has problems at the moment. It needs to build aggregate demand to keep full emploment, but the Spanish central bank cannot implement a large fiscal support package to help the Spanish economy. It has to rely on Brussels.

Artful_Dodger's picture

Good stuff.

I was discussing this same topic earlier with someone from Slovenia. I sent this post to him...



Bubby BankenStein's picture

I wonder how much CDS was bought @ 12/08 prices, and what those positions are worth now.

AN0NYM0US's picture

here's data as of this past Friday Oct 30

deadhead's picture

great stuff cheeky.