The Dangers of a Default Position
By RICHARD BARLEY
The default debate has gone global: In both the U.S. and Europe, markets are confronting questions about the sanctity of government debt. If handled wrong, this risks triggering a fresh financial crisis.
European politicians and central bankers are at loggerheads over whether Greece's private creditors can accept changes to their terms without triggering a default. In the U.S., there is talk of a "technical" default on Treasurys if agreement cannot reached in Washington on raising the debt ceiling.
A key risk from Greece is that a default of any sort would pile pressure on Ireland and Portugal.
.The problem: If it looks like a default and smells like a default, it probably is a default. Using the word "technical" doesn't change the reality if some Treasurys aren't paid on time. The same goes for Europe. Even if banks "voluntarily" roll over their debt, it is hard to see that as truly an act of free will. Standard & Poor's downgrade of Greece to triple-C—making it the lowest-rated sovereign in the world—specifically fingers the latest German debt swap proposal as a default.
Europe's politicians may end up lending Greece more money, as the European Central Bank clearly opposes anything that resembles a default. U.S. politicians may agree to raise the debt ceiling from $14.3 trillion before the cut-off date of Aug. 2. Even after that, Treasury Secretary Timothy Geithner can prioritize outgoings to favor debt payments. But with a monthly budget deficit of $124 billion, according to Fitch, the risk to debt service will build quickly. On Aug. 15, $52 billion of payments are due.
What if politics means bond payments stop?
A key risk from Greece is that a default of any sort would pile pressure on Ireland and Portugal, where debt dynamics aren't as bad, to follow suit. The ultimate risk is contagion upending Spain, whose €1.1 trillion ($1.59 trillion) economy is too big to bail out.
.In the U.S., there are three main channels through which financial turmoil can spread. First, short-term funding may be disrupted. As investor Stanley Druckenmiller argues, holders of long-dated Treasurys might accept a short delay in payments in exchange for the political face-off in Washington leading to a credible program for fiscal repair. But those holding maturing debt are unlikely to agree. For money-market funds, liquidity is everything: a failure to pay risks a new Lehman-like run.
Second, more than $4 trillion of Treasurys are used as collateral for repurchase agreements, futures and derivatives, J.P. Morgan Chase notes. A greater discount on this collateral due to increased credit risk could cause turmoil.
And third, while U.S. investors might stick with Treasurys, foreign lenders may see it as another reason, on top of the falling dollar, to reduce exposure.
There is one key difference between the two situations. Greek credit risk is real, given a soaring debt burden, loss of market access, shrinking economy and the country's inability to print euros. The default debate is necessary, although it has been poorly handled.
The U.S. default threat, by contrast, is unnecessary and threatens to introduce credit risk into what has been seen as the safest asset in the world— a dangerous development. With the global financial system still so fragile, this isn't the time for politicians to raise the stakes.
Gates Warns of South China Sea Clashes Without Code of Conduct Agreement
By Daniel Ten Kate - Jun 4, 2011 11:00 AM CT
U.S. Defense Secretary Robert Gates warned that more clashes will occur in the South China Sea if nations vying for oil and gas in the waters fail to agree on ways to avoid confrontations.
“I fear that without rules of the road and without agreed approaches to dealing with these problems, that there will be clashes,” Gates said yesterday at the annual IISS Asia Security Summit: The Shangri-La Dialogue in Singapore. “That serves nobody’s interest.”
The defense ministers of Vietnam, the Philippines and Malaysia, all of which have disputes with China in the sea, will speak on maritime security issues today. Chinese Defense Minister Liang Guanglie is scheduled to give a keynote address on China’s international security cooperation.
Tensions have risen in the South China Sea in the past month. The Philippines filed a diplomatic protest after Chinese vessels were seen in an area claimed by both countries, and Vietnam last week said Chinese ships cut survey cables of a boat operated by Vietnam Oil & Gas Group, or PetroVietnam.
China’s claims to most of the South China Sea have sparked protests from neighboring countries that rely on the U.S. Navy as a stabilizing force in the strategic lanes. Exxon Mobil Corp., Talisman Energy Inc. (TLM) and Forum Energy Plc are all planning exploration activities in blocks with Chinese claims.
‘Space for Diplomacy’
“Disputes in the South China Sea appear to be growing in intensity and even bringing naval forces into contact with each other,” said John Chipman, director-general of the International Institute for Strategic Studies. The meeting in Singapore “will be an important opportunity to reduce tensions and offer space for diplomacy,” he said in opening remarks on June 3.
China asserts “indisputable sovereignty” over most of the South China Sea, including oil and gas fields more than three times further from its coast than they are from Vietnam.
“It would be a mistake for us to see China as an adversary,” Malaysian Prime Minister Najib Razak said in a speech on June 3. “If we treat China in a very constructive, positive way, I’m more than convinced that the Chinese will respond positively to us.”
Najib said he’s “optimistic” the 10-member Association of Southeast Asian Nations can sign a binding code of conduct in the waters. China and Asean have struggled to reach an agreement that builds on a less formal 2002 pact.
Such an accord “would clarify” many of the recent clashes in the sea, Gates said.
China and the U.S. are the world’s biggest spenders on arms. The Pentagon is requesting $671 billion for fiscal 2012 starting Oct. 1, $37 billion less than this year’s request. China plans to increase defense spending 12.7 percent this year to 601.1 billion yuan ($92.8 billion), a figure U.S. analysts say underestimates actual outlays.
Exploration in waters under China’s jurisdiction infringes its “sovereignty and interests and is illegal,” the Foreign Ministry in Beijing said May 12. China has bolstered its forces over the past decade, procuring nuclear-powered submarines and developing an aircraft carrier, according to a Defense Department report in August.
The U.S., which has defense treaties with the Philippines and Thailand and guarantees Taiwan’s security, has patrolled Asia-Pacific waters since World War II. Gates reiterated concerns this week over China’s development of advanced military technology, including anti-ship ballistic missiles.
To contact the reporter on this story: Daniel Ten Kate in Singapore at email@example.com