Sovereign Debt Spiral


The Greek debt tragedy currently unfolding may be the canary in the coalmine to the ultimate unraveling of the European Union.
The weapon of mass destruction is public-private partnerships. The special entities where private industry takes loans out for government projects and the sovereign entity become guarantors of the loan. As the European countries struggle with their budgets the PIIGS (Portugal, Italy, Ireland, Greece and Spain) are seeing an explosion in monetary exposure to these public private guarantee of notes.

Gordon Long, founder of a private venture capital fund, in an investor note says there is over $600 trillion in notational value in the global derivative market with $437 trillion of these tied to interest rate swaps. “Any credit event could trigger a cascading event. It does not have to be default; it could be a downgrade in swap contracts that would do the trick for a collateral call. Something is going to cause it to topple, whether it’s a situation in Dubai, Greece or New Jersey.”
With this as a backdrop, is it any wonder why the US dollar has been on strong run since last November against the euro and the British pound. Also gold versus the euro has risen16 percent in the same timeframe.
Major investors also have a record number of future bets that the euro will continue to depreciate against the dollar over the short term.
“The next 12 months could be very dramatic for the Eurozone,” said Robert Chapman, publisher of “The International Forecaster.”
“ I am seeing many sovereign defaults for the PIIGS as well as in eastern Europe and the former Soviet satellite countries running into 2011,” Chapman added
Industry newsletter estimates have Dubai’s sovereign debt load exploding to nearly 4 times its originally reported $80 billion, as other government-back projects have gone bad after Dubai World’s default in late November.
The scenario went something like this:
¡ In 2005 a government like Greece wished to develop a Mediterranean beachfront location for tourists.
¡ The Greek government did not want to float infrastructure bonds to pay for the development because it debt load was over the ceiling threshold set by the EU.
¡ The Greek government brings in a Wall Street bank like Goldman Sachs, which suggests it establish a Special Purpose Vehicle.
¡ This SPV in essence allows the public development company to finance the infrastructure project with the Spanish government guarantying the debt.
¡ The project moves forward with not credit impact on Greece’s credit rating.
¡ When the housing economy goes south the developer declares bankrupt and the Greek government must add this debt onto its books.
So when this scenario is played out a thousand times across the Eurozone the bond ratings of the sovereign countries are lowered thereby increasing its borrowing costs and could eventually lead to a default.
This is how the Greek debt has grown 12 times over the initial numbers it had on the books with the European Union.
Iceland and Dubai are the test studies for how the Europeans may deal with the idea of socializing private debt through public funding.
Dubai World’s default, which had government backing, put the world on notice that sovereign credit worthiness was a concern.

And just yesterday Icelanders overwhelmingly voting “no“ in a referendum on a $5.3 billion deal to compensate Britain and the Netherlands for deposits lost in a collapsed Icelandic bank and daily riots in Greece over government tax policy changes, this may end poorly.
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