Willem Buiter is provocative, but he may be correct. Any country other than the US or Japan would have seen capital flight in response to their economic crises. But in a world of risk, both countries experienced capital inflows because they were seen as the sovereign of last resort, or, the least risky of all risky assets. If Buiter is right, what will be the new save asset?
Sovereign Debt Unsafe, Default Concern Spreads to U.S., Japan, Buiter Says
Bloomberg, By - Jan 7, 2011
Fears of a sovereign default are “manifest” in Europe and will soon spread
to Japan and the U.S.
as governments struggle to control deficits, according to Citigroup Inc.
economists led by former Bank of England policy maker Willem Buiter.
“Despite the recent drama, we believe we have only seen the opening and
second act, with the rest of the plot still evolving,” London-based Buiter and
colleagues wrote in a research note published today. “There is absolutely no
The warning comes after the threat of default forced Greece and Ireland to
seek bailouts and as borrowing costs for Portugal this week surged at a
six-month bill sale as investors speculate it will be next to seek aid.
Elsewhere, U.S. lawmakers
last month extended tax cuts and are now wrangling over whether to raise the
nation’s debt limit, while Japan’s
public debt is set to exceed twice the size of the economy this year.
“The U.S. and Japan likely cannot continue to ignore the
issues of fiscal sustainability,” said the Citigroup economists, who added that
it’s “only a matter of time” before the U.S. government can only fund
itself through debt issuance at “significantly higher interest rates.”
Concern of default will spread especially if the definition is extended
beyond violating legal contracts to include the infliction of losses on
bondholders by deliberately engineering inflation or currency depreciation, the
Several debt restructurings will occur in the euro area in the next few
years and the current system of providing liquidity won’t be enough to prevent
them, the economists said. Greece’s
government is “manifestly insolvent,” they said.
Western European government bonds are now riskier than emerging-market debt
for the first time as investors brace for $1.1 trillion of borrowing from
euro-region nations this year.
For a lasting solution, the sovereign-debt crisis must be addressed at the
same time as weaknesses in the region’s banking system, the report said. In Ireland, for
example, the recent aid package will “buy time,” yet fails to address fault
lines in the country’s banking system and highlights the need for a
continent-wide regime to deal with them, it said.
Portugal is likely to be
the next country to access the regional rescue fund soon, yet the almost $1
trillion system of support “looks insufficient” to prevent a speculative attack
or to fund it completely for three years, the economists said.
In a separate report also published today, JPMorgan Chase & Co.
economist David Mackie said there is concern that if Spain
seeks help “the current arrangements will not be able to contain the crisis”
and that doubts about whether debt sustainability can be achieved without
restructuring would linger and contagion could spread to Italy and Belgium.
“If that were to happen, euro-area policy makers would need to enlarge the
current facilities,” said Mackie, noting that could involve moving to a system
of debt guarantees and reducing the borrowing costs on the emergency cash.
The chance of the 17-nation euro area breaking up is nevertheless “extremely
unlikely and would be an economic disaster,” said Buiter’s team, adding that
exiting the region would be “irrational” for fiscally weak countries such as Greece.