Beware Of Greeks And Mexicans Bearing Gifts

The stock market was badly rocked by the perception that the economy in the euro zone may be recovering much more slowly than the rest of the world. The crisis in Dubai may be over, at least for several months. It appears that the desert kingdom does not have enough capital to cover all of its debt obligations despite the $10 billion in financial aid from its neighbor Abu Dhabi. The European crisis may be just beginning. Greece, Ireland, and Austria have all been flagged by credit agencies for being at risk for defaulting on their sovereign debt. As the AP wrote, Ireland and Greece both are running double-digit deficits and struggling with a basic duty of euro membership — to keep budget deficits within limits.

The Greek Prime Minister promised that his nation would balance its budget. The nation’s deficit is 13% of GDP. Greece’s debt is estimated at 300 billion euros, according to The New York Times. That is more than 110% of gross domestic product. Prime Minister George Papandreou said he would cut the nation’s budget by 10% and strive to get his nation’s budget deficit to below 3% of GDP by 2013. These are the promises of a politician who, no matter how well-intentioned, has to deal with the legislative branch of his government and the realities of a national economy that is still effectively in a recession. A major purpose of announcing good intentions is that the premier hopes that the capital markets will look more favorably on his nation’s bonds.  He is asking for investors to trust him, and really nothing more.

Greece’s single largest problem is that it does not have a neighbor like Abu Dhabi that is so wealthy from its oil production that it has access to $10 billion to give aid to another nation.

The sovereign bond market has quickly been stripped down to a foundation where investment risk is based on trust. Since the Dubai government surprised the world by announcing its intentions to allow its national financial investment firm and its real estate holding company to go into defaults, trust was squeezed out of the system almost entirely.

The trouble in the sovereign debt markets is not limited to Europe and the Middle East. S&P recently downgraded Mexico’s debt to one level above “junk” cutting it to BBB from BBB-plus. Mexico’s crude production has dropped for several years. The lack of oil income has helped the country create a huge deficit. Agustin Carstens, the man who is about to become the head of Mexico’s central bank, played the role that Prime Minister Papandreou did in Greece. He told the federal government in his country and all world’s investors who hold Mexican debt that there was little or no risk in holding his country’s paper. “The revisions that have been made to our rating in no way imply unsustainability,” Carstens told the Mexican Senate finance panel, according to Bloomberg.

The sovereign debt problem that emerged earlier this year has silently begun to spread. At mid-year, the problem appeared to nearly disappear. In the past two weeks, it has suddenly become acute again. It was actually acute all along. Economic trouble in the US and other large economies overshadowed these issues and kept them out of the headlines.

Global capital markets investors are now left with the prospect of relying on politicians as the last responsible authority for determining which nations will survive the sovereign debt crisis and which are not. Politicians are terribly poor credit references.

Douglas A. McIntyre