Reality Sovereign Debt Finance Theatre

“Happy families are all alike,” wrote Leo Tolstoy in Anna Karenina, “every unhappy family is unhappy in its own way.” Today’s Markets and Money looks at the unhappy family of nations in Europe and their coming family feud. Each is definitely unhappy in its way.

Yet there is a common thread to the current state of economic melancholy. It’s money. Most failed marriages, we’ve heard, end up breaking up over money. Why would Europe or America or Australia be any different?

But before we get into family counselling, let’s have a look at markets. Over in America the Dow Jones Industrials Index has closed at its highest level since October of 2008. The Dow sits at 10, 979 and has risen eight days in a row. Woop woop.

The volume figures on the Dow, however, show a disturbing lack of faith, or conviction if you prefer. The chart below shows the Dow since the March 9th low of 2009. It’s been a pretty steady rise since then. But you can see that average daily volumes are less than half of what they were when the low was made a year ago. What does it mean?

Higher Highs on Lower Volumes

Higher Highs on Lower Volumes

“It’s bearish. That’s what it means,” said Murray when we ambled over to his desk to show him the chart above. “It means there’s a general lack of conviction by buyers. You’d want to look out below.”

Where are all the buyers? Is the market just drifting higher based on programmed money flows by institutions? Granted this is an index of just thirty U.S. stocks. But it shows you that once you go below the surface of the index levels, the waters in the market are eerily calm and not frothy at all.

The other point about this is that in market-cap weighted index, a few key constituents can account for big day-to-day moves. For example, the table below from Standard and Poor’s shows the top ten weightings in the ASX/200. The financials and the miners dominate, with property, telecom, and consumer staples all making cameos.

In other words an up or down move in BHP or Commonwealth Bank has a bigger effect on the direction of the index based on the size of their respective market capitalisations. That sounds like gobbeldy gook. But the takeaway is you should beware light volumes and indexes whose higher movements are driven by just a few stocks. It shows a lack of breadth which can turn quickly and result in big sell off.

Now, you probably don’t want to talk about this. But we need to talk about Greece. Its on-again, off-again bailout flirtation with the European Union is driving the market nuts. Its reality sovereign debt finance theatre at its most dramatic. But what, really, is at stake?

The European monetary family is in crisis. It meets on March 25th and 26th to discuss whether to kick Greece off the island (survivor style) or to intervene and save the prodigal son. The problem, from a German perspective, is that Europe is full of prodigal children. To save Greece means to save the rest of the economies troubled by rising public debt-to-GDP ratios. Where will it stop? With the trashing of the euro.

But is doing nothing an option? The Greeks have already said they will meet with the IMF on April 2nd if Europe resolves nothing by the end of March. And in the meantime, bond yields on Greek debt are left twisting in the wind. Rising bond yields wipe out the benefits of austerity measures and deficit reduction.

According to Bloomberg, “The yield on Greece’s 10-year government bond rose 12 basis points to 6.21 percent. The euro fell for a second day against the dollar, slipping as much as 0.7 percent to $1.3648. Credit-default swaps on Greek sovereign debt rose 7 basis points to 295, the highest in a week, according to CMA DataVision prices.”

It’s hard to imagine the Northern European powers hanging Greece out to dry. Families are supposed to look out for each other. You do more for your family when the chips are down than you do for most people in the world. But maybe Greece will spare Germany the hand-wringing and default on its own….just throw up its hands and shrug.

The willing default on sovereign debt is what Societe Generale analyst Albert Edwards expects. In a note to clients earlier this week Edwards wrote, “Ultimately, as my colleague Dylan Grice writes, I think we head back to double-digit inflation rates as governments opt to default. I certainly again expect to see CPI inflation above 25% in the UK and indeed in most developed nations in my lifetime.”

This is the old “asset-deflation-first-then-hyperinflation-later” two-step. It’s the Big Crash dance, with the Bernanke/CNBC orchestra providing mellow tunes as your promenade your way to the lifeboats. Edwards writes that, “In the near term, however, the deflationary quicksand will suck us ever lower until we suffocate. A key driver for underlying inflation remains unit labour costs. While unit labour costs decline at an unprecedented rate, they are sucking us inevitably into a Fisherian, debt-deflation spiral. Only then will we see how far policymakers are willing to go to debauch the currency. Last year saw them cross the Rubicon. Monetisation is now the policy lever of first resort.”

Some readers think we’re trying to have it both ways on the inflation/deflation debate. But it is one of the issues you have to be flexible about and be willing to go both ways on in order to keep your money safe. Prepare for falling asset prices and a sovereign debt crisis. And then watch out as central banks reach out and take us to strange new monetary places and boldly go where Weimar Germany and Argentina have gone before.

Buckle up buttercup.

Dan Denning
for Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

Leave a Reply

1 Comment on "Reality Sovereign Debt Finance Theatre"

Notify of
Sort by:   newest | oldest | most voted
2 cents worth

Dan, can you do a essay on the possible implications of an IMF “intervention” in Greece and the other little piggies? I know the African countries where the IMF is active is not exactly uniform in their praise. Thanks.

Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.
If you would prefer to email the editor, you can do so by sending an email to