Do financial markets think Spain will default?

Sorta!

But that won't stop the government and european authorities from inflicting pain on their populations in the name of fiscal austerity.

As I'm sure Maladjusted's readers already know, Spain is the latest object of European sovereign debt fears. Following Greece's lead, Spain's borrowing costs have increased over the last two months on concerns that the government won't be able to service it's debt and will face a rollover crisis. As a consequence the government is moving ahead with large austerity plans--cutting spending and raising taxes while unemployment remains above 20 percent.

Advocates of austerity claim that if the government doesn't make tough choices to bring down its deficit and reassure creditors interest rates will spike emerging market-style, causing the debt to explode. Spain, the argument goes, will find itself forced to default on its debt, potentially bringing down the whole Eurozone with it.

Austerity advocates, in other words, argue that markets think Spain is in danger of defaulting, and if we don't heed their warning we'll have serious trouble. But first of all, that's a stupid anthropomorphism (markets don't have agency or thoughts, last time I checked). But more to the point, assuming markets are capable of "thinking" anything, do they actually think Spain is in danger of defaulting?

Well, one way of answering that question is to use the price of credit default swaps (CDS) on Spain's public debt--that is, how much it costs to insure oneself against the possibility of a default.

[Spain: Implicit probably of default, April-July, 2010]

The graph above, courtesy of Maladjusted Graphs™, shows the "implicit" probability of default on Spain's government bonds. The idea is simple: the price of ensuring oneself against a default should reflect the chance of default and how much of their money investors expect to get back in the event of a default (i.e. how big of a "haircut" bondholders expect). In other words, the price of a CDS should equal the chance of default times the haircut rate. The price to insure oneself against default is higher the higher the expected chance of default and the larger the haircut.

So, the orange line above shows the implicit probability of default under a relatively optimistic assumption about the size of expected haircuts. In this case, I'm assuming markets only expect to lose $10 on every $100 worth of bonds. As can be seen above, under this assumption at the beginning of April markets only thought there was an 11% chance of default. But then as all the sovereign debt hysteria surrounding Greece started making headlines markets started to "think" the chance of default was much higher, reaching 28% on May 6.

But here's the thing. This is only the case if markets expect the default to be a very small one. Getting back 90% of your money when a government defaults is relatively rare in the history of sovereign debt crises.

So, what if we assume Spain is like Argentina or Russia and if the government defaults investors would only get back $30 for every $100? Well, the yellow line above shows just this scenario, and as can be seen the chance of default is really, really low. In fact, the crisis hysteria back in May shows up as nothing but a tiny blip, peaking at a terrifying 3.9%!

So what's the moral of the story?

The fact of the matter is that if markets really do think a default is likely, it's not reflected in market prices, which are, after all, the only coherent measure of what markets "think." That, or they don't expect to take a very big hit in the unlikely event the government decides to default.

In other words, markets either think Spain is like Argentina but the actual chance of default is really low or they think the chance of default is high but don't expect to actually lose any significant amount of money.

Then do the markets think Spain will default? Sorta! Should the government heed their warning? No! But that doesn't mean it can't seriously structurally maladjust itself to fight imaginary threats in the meantime.

Argentina, where economic growth is a bad thing

Only with Argentina, whom investors and the business community (and press) clearly haven't forgiven for defaulting in 2001, can rising GDP forecasts be reported as a bad thing. Bloomberg reported yesterday that RBS raised their estimate of Argentina's GDP growth this year from 4.4% to 7%. Amazing you might say, that would put Argentina at the top of the hemisphere, and be a seriously nice way to rebound out of the world recession, but wait. According to RBS:

“This ‘full throttle’ growth strategy is likely to exacerbate current distortions in the economy,” RBS economist Boris Segura wrote in a report today from Stamford, Connecticut. This would leave “a heavy legacy to the next administration,” Segura said.

You know, if the US undertook a serious stimulus and our GDP forecast went up that much, this would probably be straight from a set of Republican talking points. I can see it now, "This 'full throttle' government spending is only going to drive the nation further into debt. Mr. Obama is going to leave this country in ruins for whoever our next President will be."In fact, I bet they've already said that.

Just a reminder that when reading the mainstream media's coverage of Latin America, it reads more like FOX News' coverage of Obama than what passes for good journalism on domestic issues.

Making the Case for Argentina

Not sure who to root for with the quarterfinals of the World Cup starting tomorrow? Well, Dave Zirin makes the case for Argentina, who in addition to playing "with the wicked grace of decades past", brings it politically as well:

At a training session in South Africa, the entire Argentine team unfurled a banner that read, "We Support the Grandmothers of the Plaza de Mayo for the Nobel Peace Prize." The group has in fact been officially nominated for the prize and Abuelas president Estela de Carlotto, is in South Africa, meeting with Nelson Mandela and other world leaders. She has also been publicly and literally - embraced by Maradona. The critical work that Abuelas has done will only receive a greater spotlight if Argentina continues to advance. This makes all those connected with Argentina’s dirty war, who still hold tremendous power in the country, increasingly, and deliciously, apprehensive.

I can certainly understand, and have heard from numerous people, that these kinds of political concerns shouldn’t play into our rooting interests when it comes to the World Cup. It should just be about the game. But this is like wishing a double cheeseburger didn’t have cholesterol. There is simply no sporting event on earth more entangled in politics than this brilliantly bombastic tournament. Anytime you have half the earth tuned in - as colonies play their former colonizers and dictatorships challenge democracies - politics follow like rainbows after rain. As long as politics are part of the mix, we might as well support a team that in addition to epitomizing the beautiful game stands with a beautiful cause. Viva Argentina!

I urge you to go read the whole thing, only Dave Zirin can quote from Galeano and Yahoo! Sports writers in the same piece. For those of us who enjoy our sports almost as much as our politics, Zirin is a must read. 


(image also from Zirin)

Consequences of default: Baker 1, Reinhart 0

During a question and answer series about the Greek crisis on the New York Times economix blog, economic historian Carmen Reinhart warned about the possible consequences of a Greek default by comparing the situation to Argentina's default back in 2001.

Carmen Reinhart:

"Argentina’s economy contracted 20 percent in 2001 after its default, as it was shut out of international markets for a time."

And now, with Otto's permission, I will cue owly.

But why the owl you might ask? Well, it turns out, courtesy of Dean Baker's Beat the Press, that Reinhart's account of Argentina's foreign debt default might've been slightly off...

Dean Baker:

"Actually, Argentina defaulted at the end of 2001. According to the IMF, it's economy then contracted 10.9 percent in 2002. It then turned around and grew at an average rate of almost 9.0 percent in the next five years. No one has such an optimistic set of projections for the Greek economy right now."

Ouch! That's gotta hurt.

For those of you who don't know Carmen "prodigious data sets" Reinhart, she's an economist from the University of Maryland who's recently become quite famous for her work with Kenneth "obtuse math" Rogoff documenting financial crises. These two literally wrote the book on financial and sovereign debt crises--in their 2009 bestseller, This Time is Different: Eight Centuries of Financial Folly, Reinhart and Rogoff put together a data set dissecting crises as old as 800 years ago.

In any case, one of their findings is that throughout history sovereign debt crises usually follow banking crises. And it is no coincidence that Reinhart and Rogoff have been going around warning us that we should all be really, really worried about rising public debts now that the global financial crisis has ended.

Whatever. The point is that I find it surprising and disappointing for such a big name and no doubt an authority on the subject matter to get Argentina's story so wrong; especially since her academic work is usually of such high caliber (Reinhart has also made important contributions to the capital controls literature).

GM Crops in Latin America

First the good news, Peru announced that they will be labeling foods that contain genetically modified ingredients. To the extent that countries are going to allow GM crops, labeling foods that contain them is definitely a good call. On the other hand, Latin America is literally full of GM crops, as the chart below shows (click for larger view), 9 of the top 18 biotech producers are in Latin America:



Or for those visual learners:



Most of these GM crops are soybeans, which means these farmers are literally Monsanto's (more aptly called Monsatan) bitches. For background on Monsanto, I'd suggest the excellent documentary "The World According to Monsanto". Basically this company is as close to evil incarnate as it comes.

One country where they are realizing some of the horrible effects of GM crops is Argentina. Argentine scientists recently published a study that found Monsanto's "Round-Up" to have negative health effects (surprise, surprise). For background on that, and more on GM crops in Argentina, this piece from CIP's Americas Program is pretty good.

So while we should be patting Peru on the back for labeling foods with GM crops in it, the bigger issue is the take over of GM crops throughout Latin America.

(images from the ISAAA 2009 GM crop report)

Bolivia, Argentina, Natural Gas and Doomsayers

Remember when the sky was going to fall down in Bolivia because Evo nationalized the natural gas industry? Well, it hasn't happened yet, and with a recent spate of investments and a nice lil contract with CFK, it looks like the doomsayers are going to have some 'splainin to do (or more likely they'll just keep lying through their teeth, but whatever). Reuters, with a pretty nice article really:

Bolivia will quadruple natural gas exports to Argentina by 2021 under a deal signed on Friday that extends the deadline by nearly a decade for the Andean nation to boost fuel exports to its wealthier neighbor.

But Evo's scaring off foreign investment you say? There's no way he will be able to do this with them, well Reuters continues:

But a consortium led by Repsol unveiled plans in late 2009 to invest $1.5 billion to boost natural gas output, and last month Total launched a gas exploration project, saying it may invest up to $500 million in the impoverished nation.