Sovereign risk and derivative domino effect.

While this web site was originally devoted to unhealthy imbalances
in the United States, these are currently present all over the globe.

As we have seen lately, as sovereign debt issues surfaced in Greece,
CDS market rapidly started pricing sovereign risk higher in other PIIGS
(Portugal, Italy, Ireland, Greece, Spain), the UK, Germany, and the US.

These imbalances in an isolated country normally occur after a financial
crisis, when the government attempts a Keynesian approach to fight
the crisis. If the fight is unsuccessful, the government assumes too
much debt, while the economy does not recover, a currency crisis
will follow (Argentina 2002, East Asia 1997, Russia 1998, Iceland 2008,

The financial crisis of 2008 was global in nature, and the Economist
has a wonderful discussion of what might follow if the global economy
does not recover due to too much debt. I believe this is coming –
perhaps, later in 2010 or in 2011, as a consequence of the global
financial crisis of 2008.

Sovereign-debt worries – the Economist.
Domino theory
Assessing the risk that Greece’s woes herald something far worse

HOW far is it from Athens to America and which
countries lie on the way? That may sound like an esoteric geography
question, but it is being asked by investors as Greece’s debt crisis
creates global jitters about the safety of sovereign debt. So far
Portugal, Ireland and Spain, the other high-deficit countries on the
periphery of the euro zone, are thought to be next in line. In most big
rich economies, yields have been stable and well below their long-term
average (see chart).

But nerves are fraying elsewhere. The cost of insuring against
sovereign default (see article) has risen in 47 of the 50 countries for
which these instruments exist. Dubai’s sovereign credit-default-swap
spreads soared to their highest level in a year this week, amid concern
about the terms of a debt restructuring by a state-owned
conglomerate. There is increasingly shrill commentary arguing that
Greece is the start of a far bigger problem. “A Greek crisis is coming to
America”, blared the headline on a recent Financial Times article by
Niall Ferguson, a financial historian.

The stakes are high. A sudden loss of confidence in all sovereign debt,
and especially in American Treasuries, the world’s benchmark “risk-free”
asset, would have calamitous consequences in a still-fragile recovery.
Equally, an exaggerated fear of sovereign risk could prompt
governments into premature fiscal austerity, which might itself push
the world economy back into recession…..

Sunday, April 25th, 2010 The global financial and economic crisis

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