On April 26th, Standard and Poor’s downgraded Greece’s credit rating, and Greek sovereign credit default swaps (CDS) climbed to 825 basis points – far higher than before the IMF and European Council of Ministers announced a support package. The Greek crisis is clearly unresolved. Some have argued that if Greece had never switched from the drachma to the euro it would have been able to pursue a fiscal policy that fit its domestic needs without depending on international capital markets. Yet Greece consistently relied on non-drachma debt issuance well before it adopted the euro in 2001. In the six years before joining the euro, only 27% of Greek debt was issued in drachma. At the end of 2000, just before Greece joined the eurozone, 79% of its outstanding debt was already denominated in euros, and a mere 8% in drachmas. Even if Greece had remained outside the eurozone, its dependence on euro borrowing would only have increased. A falling drachma would merely have brought the current crisis to a head earlier by accelerating the rise in Greece’s debt-to-GDP ratio (think Iceland). The fact that the euro is not an “optimum currency” for Greece, or any other eurozone country for that matter, is not the main problem. That problem is excessive foreign borrowing, a problem with which Greece has struggled since the early 19th century. Read more »

As the global financial crisis went viral in September 2008, governments stepped in with enormous financial commitments to prop up their financial systems. Markets became increasingly skeptical that sovereigns would be able to meet their obligations, as illustrated by soaring CDS spreads. Spreads began falling in March of 2009 as the financial system stabilized. Yet whereas Ireland pushed through unpopular spending cuts in early 2009, Greece failed to initiate serious measures to reduce public spending commitments. Consequently, markets began pushing up Greek CDS spreads in late 2009, producing an enormous gap vis-à-vis Irish spreads. Greek spreads narrowed slightly after the European Union made its vague pledge last week to “safeguard financial stability in the euro area as a whole,” but default fears remain high. Read more »

Fitch Ratings downgrade of Greek government debt has raised concerns about sovereign default risk. Within the Eurozone these concerns are particularly relevant because countries cannot print money to buy their own debt. These charts demonstrate a strong link between high deficits and high credit default swap spreads (CDS) – the market’s view of sovereign risk – and a very weak link between CDS spreads and overall debt levels. For example, although Ireland’s debt level is lower than Italy’s, Ireland, with a higher deficit, has a larger CDS spread. Investors fear deficits more than debt levels because deficits test the market’s willingness to finance a deteriorating balance sheet, while high but stable debt levels do not. Read more »

The United States is rapidly approaching its legal debt limit of just over $12 trillion. As of September 2009, U.S. debt stood at $11.9 trillion. As these charts indicate, Congress has raised the limit four times in the past three years, as the need for financing has risen. Some hope that the limit will encourage fiscal responsibility. Others fear that this exercise raises the risk of a technical default, as nearly occurred in 1995, which would disrupt markets and potentially impose severe costs on a struggling economy. Read more »

Near zero T-bill yields throughout 2009 is keeping U.S. debt service low even though the amount of outstanding debt continues to rise. A forecast increase in U.S. interest rates, along with growth in the amount of debt, will lift interest expenses sharply over the next ten years. In fact, as this chart shows, interest payments are projected to surpass defense spending by 2017. According to the Bureau of Economic Analysis, which collects data back to 1929, interest payments have never surpassed defense spending. Read more »