Sovereign crisis

first_img Facebook Twitter: @NeosKosmos Instagram Having asked readers to tell me what’s really confusing them about the current economy, the answer seems to be the sovereign debt crisis and what it means for Australians. Sovereign debt means government debt, and governments – just like businesses and households – spend more than they earn, and borrow more than they can pay back. In Europe, this has been happening in a drastic way since the worst of the GFC. Greece, in particular, is in very bad shape. With a debt to GDP ratio that’s forecast to be 166 per cent by 2012 (that’s $1.66 owed for every dollar earned) and a $145 billion bailout package that didn’t work, the Greek government is teetering on the brink of defaulting on its debt. The ‘problem’ becomes a ‘crisis’ because as it tries to raise more money by selling bonds to pension funds and foreign governments, the Greek government is considered such bad risk that the markets want a 26.5 per cent interest rate for Greek two-year bonds, where they were 4.5 per cent just a couple of years ago. Even if they could sell their bonds at 26.5 per cent, they couldn’t service the repayments. The markets now wait to see who or what will bail-out the Greek government (China or Germany, most likely), but in the meantime, what they call ‘contagion’ spreads to other countries. In the past few months, the markets have re-priced the bonds (debt) of Portugal, Spain, Ireland and Italy. The global markets are steering clear of European sovereign debt. How does this hurt Australia? There are several scenarios. In one, Greece, Ireland and Portugal are bailed-out by a syndicate of countries and banks, and operate under strict new budget guidelines for many years. Another scenario is that Greece can’t politically accept budgetary conditions of a bail-out package and it defaults on the massive debt it owes. That is, it stops paying the interest on the bonds it has issued. Investors would not only pull out of investing in Greek government bonds, but would probably pull back from European bonds in general, considering the Euro Zone a risk not worth taking. This pessimism would infect a third-tier country like Australia and the result for us would be a reduction in liquidity in our credit markets. We’d feel it in mortgage and business credit squeezes as the flow of funds available for lending is reduced. It shows you how important confidence is, not only in the high street, but in the capital markets. It also demonstrates how global the financial system has become – something the Reserve Bank has to think about before it sets official interest rates each month.last_img read more

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