€urosclerosis, part 6: What it means for the United States

From :

Signs of Market Stress Emerge in Europe, U.S.


Global markets are showing some signs of stress not seen since the 2008 financial crisis amid alarm at the expansion of Europe’s debt troubles.

Strains appeared on both sides of the Atlantic. The cost for European banks to swap euros for dollars climbed to levels last seen in late 2008. Pressure also was felt in the U.S., where higher funding costs were registered in markets for commercial paper, interbank lending and securities repurchases, or repos, all key sources of short-term financing for banks and corporations. The two-year swap spread, a gauge of how market participants feel about the risk of default by counterparties, widened to levels last seen in May 2010, when the Greek crisis initially flared.

European bond markets continued to creak as buyers remained scarce. Spain was forced to offer record euro-era yields at its government-bond auction Thursday, reflecting investors’ demands for higher risk premiums.

Much more at the link, and that much more isn’t very encouraging. The authors continue to note that not only are countries in financial trouble having to pay higher interest rates to sell their bonds, but even countries which retain AAA credit ratings — France, the Netherlands and Finland were cited — are being hurt in selling bonds. The reasons are obvious: the European debt crisis has investors leery, and they know that countries which may seem financially stable today are nevertheless at risk of overborrowing in the way that Greece and Italy have done, and may be, in time, riskier than their AAA bond ratings of today indicate. The “spread,” or the difference between offer (or ask) and bid prices, was larger than during the financial collapse of late 2008.

Investors and banks are now holding dollars, because, despite the United States’ own debt problems, the dollar looks safer than the euro right now. But the statistics given in the article for Italy are sobering:

Roughly 55% of the $1.1 trillion in outstanding Italian government bonds were held by asset managers, banks and official institutions outside Italy at the end of the first quarter.

In other words, countries like Italy depend on companies like Standard Life PLC to buy their debt. But the Edinburgh insurer has been retreating from Europe over the past three weeks, cutting exposure to the entire Continent with the exception of German, Finnish and Dutch bonds, said Jack Kelly, Standard’s global head of fixed income.

Foreign governments hold roughly 46% of publicly held US debt. At the end of September, the People’s Republic of China held $1,148.3 billion in US public debt, out of a total of $4,660.3 billion in US debt owned by foreigners. If Standard Life PLC of Scotland, previously a reliable purchaser of European government bonds, starts to back away from “exposure” to the Continent’s financial problems, why would it be unreasonable to believe that the Chinese might start to demand higher interest rates or back off entirely from buying additional American debt instruments if the United States doesn’t start showing signs of a more reasonable fiscal policy?

It doesn’t even need to be an economic concern. President Obama announced on his visit to Australia that the US plans an expanded role in the Pacific, including an increased military presence in the region. Hu Jintao might not be all that pleased with such a policy, and all he needs to do is lower their bid price vis a vis the offer price on United States Treasury Bills, and costs to the government for financing our debt increase, meaning that funds available to put President Obama’s policies into action decrease.

Because we borrow so much money, and because we borrow it from other countries, countries which might not have our better interests at heart, we have made ourselves vulnerable, in many ways more vulnerable than we are to oil exporting nations. The petroleum exporters cannot drink their oil; it is useful only if someone gives them a liquid asset — dollars — for it. But China already has dollars, and they do not have to spend them on US Treasury Bills; they are liquid and completely useful in buying anything else the Chinese wish to buy.

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