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European Debt Situation Improving?

January 20, 2012 by  

European Debt Situation Improving?

In 2011, financial markets were dominated by news surrounding the debt problems in the Western world, and markets saw record levels of volatility. The issues in Europe as well as in the United States are equally alarming, and the coming months will show us whether policymakers are able to stabilize the situation.

The structure of the problem might be very similar; however, Europeans and Americans deal with it differently. While Europe seems to be engaging in a more active discussion about how to deal with its situation, the United States has not made a lot of progress in getting its house in order.

The risk Europe faces is that it might cut spending so much that the austerity measures cause the economy to contract significantly. The measures taken might have far-reaching consequences, and the contracting economy might eventually cause actual government income to decrease. Lower spending and lower income would result in a stagnant, high deficit.

On the other hand, the United States is trying to be less aggressive. While cutting spending is important, officials are trying to do so in a bit more moderate fashion than Europe.

It has yet to be seen which strategy will work better, but it seems to be obvious that inflation eventually becomes part of the solution. Ultimately, inflation could play the greatest role in solving the problem, if the size of the existing debt were devalued by an increase in inflation. In that sense, a devaluation of money would cause inflation. Savers and creditors would be hurt the most, while people with debt would see their situations improve. This summarizes the main structure of the problem as we have outlined in previous reports.

It should be obvious to everyone that the global economy and financial markets will continue to be heavily influenced by the way the Western world deals with its debt problems. Therefore, I would like today to look at the recent developments, especially in Europe, in order to judge the situation and whether an improvement can be expected soon.

Given the recent downgrade of the Eurozone countries by the rating agency Standard & Poor’s, one might think that the situation has worsened since the start of the year. However, I think there is reason to believe that the situation might improve in coming months. A number of European countries have tested the market since the start of the year by selling short- and long-term bonds to investors. These bond auctions have been quite successful, not only with regard to the actual demand for these bonds but also in terms of the yield investors demanded.

Yield spreads for Italian and Spanish debt have fallen significantly from the levels seen in the last quarter of 2011. For example, Italy is paying a yield of 4.83 percent for bonds maturing in 2014. That’s almost 1 percent lower than what it had to pay in December. For bonds maturing in 2018, the yield was 5.75 percent also down significantly from 2011 levels. Also, Spain had a number of successful bond auctions.

Another sign that the “fear premium” for European sovereign paper is falling is shown by the results of the German bond auction last week. The country paid a yield of 0.9 percent for five-year bonds, setting a new record low. Demand for European government paper has also improved, with demand exceeding supply by a wide margin. Germany’s auction, for example, attracted almost twice the amount in bids than what it had to offer.

While some people think that the recent slide in yields was caused by some kind of “behind the scenes” central bank intervention, this argument fails to explain the broad-based slide in government yields. In my view, this development reflects a general move to a more “normal” market environment again.

Last year, fear and panic resulted in a hysterical market environment, sending yields of European governments bonds to record levels. Just two or three years ago, we had the exact opposite extreme when Italian and Spanish yields were almost as low as German yields, therefore reflecting little to no risk premium. Looking at the economic fundamentals, it should be clear that this was also a general mispricing of credit risk. A reversion to the mean had to happen at some point.

We have now witnessed an overreaction to the upside; and, once again, we expect yield spreads to move back to fair value. Fair value in this case means that Italy and Spain have to pay higher yields to attract buyers like they had to do historically.

While the start to the New Year has certainly been encouraging, it remains to be seen whether the situation will improve further. Italy and Spain face a number of tests in coming weeks, as they are going to renew a lot of debt for longer maturities. A continued trend toward a further normalization of yields would be very encouraging, but this is possible only if the European Union finds a solution for Greece’s financial woes.

Despite the relatively small size of the country, it is important in the overall context. There is real risk that Greece will default on its debt obligation should it not be able to negotiate a debt restructuring with its creditors (banks, hedge funds, etc.). While these lenders seem to be willing to accept a cut of up to 50 percent of their positions, they do not seem to agree on the rate/yield at which the debt is being rolled over. Should Greece find an agreement with its lenders on how to restructure the existing debt, then I think it is possible that the European debt situation can be managed. Of course, it is not going to be enough just to cut spending; troubled countries need to work out plans how to make their economies more competitive and, therefore, stimulate growth in the long run.

The debt problems in the Western world are far from being solved. Actually, the Western world might not be able to solve these problems entirely, at least not in the next decade. For now, the key is to make one step after another and make policy changes and structural reforms that make sense. The pressure from financial markets is finally forcing change, and governments are measured by their ability to balance their budgets. This will be a key issue as a large number of major governments face election tests this year.

Daniel Zurbrügg

is the Managing Partner of Alpine Atlantic Global Asset Management, a Swiss-based independent investment management firm. The firm provides clients with independent investment management, asset protection and family office services and is the issuer of the global investment newsletter Echo From The Alps. With a global network of partners, Alpine Atlantic's aim is to provide clients with true "turnkey" solutions for global investing. Prior to setting up Alpine Atlantic, Daniel held various positions with other banks and financial companies. Daniel is a Chartered Financial Analyst and regular guest speaker at international investment conferences.

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  • s c

    We’re told that debt situations are a state of mind. Since central bankers run financial matters around the world, we’re always ‘in good hands.’ Even Ben the Boob deserves his lofty reputation, no matter how much his deeds resemble disco dancing in a mine field (blindfolded, and on one foot).
    It’s reputations that matter. If a country gets into trouble, let that country get itself out of trouble. A central bank is more important than mere people, and its needs and wants trump that of a herd of yahoos who are closer to useless eaters than are any central bankers (ask Kissinger about that).
    Word has it that banks are instruments of divine inspiration, and as everyone knows you can’t get closer to heaven than a central banker who runs that central bank. Let nations rise and fall. What really counts is the integrity and money-making power of central banks.
    If you don’t have priorities in this life, you’re just not pulling your weight (hence, ‘useless eaters’). The head of a central bank should run a nation (just like here in America). NOTHING can go wrong when you’re in charge of the 24/7 printing presses. It’s that simple, folks. Just ask the head of ANY central bank. There OUGHT to be a LAW.

    • home boy

      unfortunetlly , the credit system of the world keeps every economy flowing. without it the world collapses. we are controlled by few and we are screwed.

      • Lastmanstanding

        For now…print money, create inflation… USA is not exempt.

        • Old Henry


          I figured that “The One” would simply modify the laws of economics – and physics – and make it all good. Yooooou mean….. we’ve been lied to??

          • Lastmanstanding

            OH…only when their mouths are moving!…that gives a whole new meaning to,” silence is golden.”

  • skyraider 6

    Reelect no incumbants

    • clarence swinney



      saves 200B on tax preparations




      clarence achmed swinney madmadmad at Inequality in America boom

      • ChristyK

        Estate taxes are evil. They kill small businesses and family farms/ranches. This leaves nothing left except the big, impersonal, too big to fail corportations. Do you want Monsanto to control all our food? We need the small family farms and ranches, but when the head of household dies, the farm doesn’t make enough money to pay the taxes and they have to sell the farm/ranch. The whole family loses their livelyhood. Farmers/ranchers are not rich, but their property is worth a lot if sold. Small businesses have the same situation. They aren’t cash-rich enough to pay the estate taxes, so the assets get sold off to pay taxes and people lose their jobs. It is not right that someone who works their butt off growing a business, is not able to give it to their children to run, but has to sell it to pay the government. Who owns the profit earned from years of hard work, the worker or the government?

        • Old Henry

          Well stated ChristyK. Farm land in my area in the last year has been selling for $5K to $7K per acre – for FARM LAND. So, when the owner assumes room temperature the family must pay taxes on land that is GORSSLY OVER-VALUED and can never ever pay for itself.

          • GILLYSROOMS in Australia

            For those who know of English history when the kings had serfs who paid taxes to the Sheriff of Nottingham? Do you feel you are paying rent on freehold farms and taxes on your produce to the King..better known as Uncle Sam? ? Yes we have gone back to the medievil times and we did not realise it.

      • ChristyK

        Also, what in the world is a progressive flat tax? That is an oxymoron. Progressive and flat are polar opposites.

  • Sirian

    The present situation amongst the Euro banks, the Fed and others is that they have been and are being hit by various outside players in attempts to collapse them. So far, they have managed to do a pretty good job. Yes, the idiotic governments of the Eurozone and members thereof that have produced the mess that they and we are now in hold a major portion of the blame but still, with these idiots, new replacements included, not understanding how openly vulnerable they both were and remain it will not be much longer before both the Euro and the U.S. dollar will be collapsed. The U.S. dollar will no longer be the main reserve currency that the world runs on. There is stifling amounts of information available that has been presented to so many within the halls of our government yet it was conveniently, politically driven and ignored until now. As to the direction they feel they may be able to carry us is unknown. Yet it doesn’t appear in any way, shape or form that the present ladder we keep climbing will lead us out of the financial pit they’ve dug. We will see many changes over this year – good, bad and ugly.

  • OneDamnAngryAmerican

    Sorry, folks, but WE ARE ALL BEING LIED TO BY THE LIBERAL AMERICAN MEDIA! If you want news about Europe, I suggest you go the the BBC and NOT to the ABC for “real” news. We are being lied to.

    Italy, as an example, only has a debt of about 1 trillion, which means that the USA is 15 to 16 times worse off, then Iraly is. Any, if li-bama has not done so yet, meaning the approval of the new QE3 and other foolish tactics, the USA ran out of money last week. This is how bad it is/was: The USA’s GDP is now MORE than what the feds take in, for taxes. That means, we are bankrupt. That is why there is all of this class war-fare stuff going on. Example: Why does Romney only pay 15% on his taxes? Because the 15% is what all Americans pay on their taxes, for dividends/savings interest, etc., and that that 15% has nothing to do with the tax rate that is paid on “earned” income. That is the reason, and only reason why both Romney and Buffet only pay 15%. Remember, that 15% is for interest payments and not for taxes on their “earned” income (neither has any “earned” income. That is why all these rich folks say they only get paid $1 per year (in wages)! Only problem is, that nobody (except me, it seems) is smart enough to have figured that one out. Why? Because keeping us Americans stupid, ignorant, and dumbed-down, is all that the feds want out of life.

    Here’s another: During last year’s rain storms, two nuclear reactors were at risk from the water (just like in Hapan, a year earlier). One was in Nebraska and the other was in Harper’s Ferry. The HF reactor, if it went teats-up, would have had nuclear effects as far north past NYC. NYC!!?? Think about what that one would have done. Of course nobody ever told US about it. We all would have went to DC and tar-n-feathered everyone that was wearing a “suit.” WAKE THE “F” UP AMERICA, WE ARE BEING SCREWED! And, you we are all too stupid to realize it!

    • clarence swinney

      2.TAX CUTS–$1812
      3.STIMULUS -$773
      6.PART D–$180
      TOTAL=$5070 BILLION

      2.TAX CUTS—-$425
      TOTAL=$1440 BILLION

      BUSH 9-30-01–$5,700B—TO—9-30-09– $11,900B (+ $6200)
      OBAMA—9-30-09 $11,900– TO–9-30-11– $14,790 (+ $2810)

      • Ellen

        Sorry Clarence, but your information is incomplete and the Democrats were in charge of all spending for the last 2 years of Bush’s presidency. Look at the government’s own website to find the data on our budget/debt increases since Obama took office. Also, the CBO projections on the cost of Obamacare are completely wrong and the CBO has stated this. They are required to make projections based on the data they receive and the data received from Obama is incorrect. The Bush tax cuts worked as intended and bring in more federal taxes than the higher Clinton rates. The problem is that government spending has doubled in the years since those rates went into effect. If government spending had not doubled, we would have a budget surplus each year. Medicaid has doubled because 40% of all babies born each year are born illegitimate and into Medicaid/welfare. Welfare costs over $1 trillion annually. Most of this is completely avoidable, as taxpayers should not be held responsible for women who choose to have illegitimate children or for women who are here illegally and wish to collect welfare by having anchor babies. Our foolish give-aways have bankrupted us already and have destroyed our education system.

        • Buddy

          Ellen: It’s correct that the USA government (among other governments) is spending money they don’t have and have no hope of ever getting. The problem is not because of this or that administration but because of the mind set of office holders.
          Of course, most people like to get “free money”, which is what about half of the residents (both legal and nonlegal) think they are getting. And they want to get it now. Just like in the concept of “To each according to his needs”. That never worked out very well, but remains popular in most “democratic” (or mob-rule) governments because that’s the coin which pays for getting elected (and being reelected).

    • clarence swinney

      why do we rank in OECD nations?
      #2-least taxed corporations
      #3 least taxed nation
      #4 Inequality

      Since 1980, we have been Santa Claus to rich and corporations via Wall Street Of America world’s largest Gambling casino through our Tax Book. Burn that Rich Man Christmas Tree.

  • clarence swinney

    Tax income tax data
    Total AGI was $7825 billion
    If total Income was 10,000
    Then they had $2175 in deductions
    Burn Tax Book gets that $2175B and balances our budget
    Plus over $1000B of Corporate tax deductions lets us pay down some of the debt

    Since 1980 we have allowed the Income and Wealth to be transferred to the top 10%
    Tax policies have been the main instrument
    Rich individuals and corporations have used every rationale they could conceive to justify getting richer.
    The 90% did not gain but lost. Conservatives like Heritage Foundation and Hoover Institute have used promotions justifying the redistribution. It was bought by Congress as they became indebted to Rich individuals and corporations for campaign funds. The public was sold a bill of junk goods.
    Wall Street can justify anything.

    The Middle Class must demand readjustments.

    The nation is not short income and wealth. It is just top loaded. It is time to flush down trickle up.

    Reinstate a true huge Estate Tax. Burn the Tax Book.
    Install a Progressive Flat, by bracket, Income tax.
    Ultra Rich individuals and corporations will no longer rip off the 90%
    It is a disgrace when he second richest man pays 11% of his income in Income tax.
    When corporations have billions in profits and pay no tax.
    Both are Un-American.
    Both are Anti-Christ

    • Ellen

      Clarence, Why is it a disgrace that the second richest man pays 11%? He’s probably still paying over $1 million in taxes. Has he taken that money from anyone else or has he earned it? Do Warren Buffet or Bill Gates take money from others? No, they create jobs for others. Also, do they receive greater services for their millions they pay in taxes? No. They are examples of success that comes from hard work. Should they be penalized for this? No, it is the premise of the American Dream. Most of their income is taxed at the capital gains rate of 15%. Remember, we get taxed on all capital gains at 15%, but we are only allowed to deduct $3000 per year for capital losses. That’s a huge risk to take, so the income tax rate should be lower. Government spending is still at the same level and consumer spending (70% of our economy) has returned to normal levels. Our economy is stalled because private investors are spooked by Obama’s looming policies, so they aren’t investing. What do you think will happen to private investors if the capital gains tax goes higher? It would kill our economy. So, forget all the class warfare garbage you have been fed and look at reality. Our personal income tax program is very beneficial to low income people, fair to middle income people, and totally unfair to upper-middle income people. The rich benefit from capital gains, but they take the biggest risk to get that reward. I do agree with you about corporate taxes, though. We have the 2nd highest rate in the world, but most major corporations find loopholes and ways to pay nearly nothing (ie: GE). Smaller corporations pay far more. It’s much like the unfairness to the upper-middle income earners.

    • s c

      Show the world whatcha got, cs. The Fed is a PRIVATE CORPORATION (right?). ALL corporations are EVIL (right?). So, using your politico-religious ‘logic,’
      then how do you look at the Fed?
      Make us proud, cs. Here’s your chance to shine – and you might even get us to think that utopins aren’t a completely lost herd of dumbed-down lemmings.

  • clarence swinney

    Reagan increased our government by 80% and Bush II by 92%.

    • s c

      For that remark, c, you get a Z. Mental incompetents usually rate an F. You rate a fricking Z, comrade.
      We tell you, and we tell you, and we TELL YOU and you STILL don’t get it RIGHT. There are ‘Republicans’ and there are conservatives. Is your head so defective that you can’t understand simple words, comrade? A ‘Republican’ is a pretender. A ‘Republican’ is a neocon and a RINO. DUHHHH!

      • Sirian

        s c,
        What you just said is exactly why I don’t trouble myself with any response to this blinded fool. It would be a total waste of keyboard time, no?

  • Tony

    The Titanic engine room is full of water and the band on the deck is still playing sweet music. When will the so called experts get rid of the BS and hunker down to providing real solutions to the economic woes of the world. The share and financial markets are a debit and credit balance sheet – someone wins, someone loses. All this talking delays to final day of armagedon where everyone loses.

    • Buddy

      Armageddon can be avoided very simply by relying on our local and state governments more and on the USA union much, much less. Why is that USA union government sacred when its overall performance has been disastrous?!

  • dick motta

    I fail to see where the United States has cut any spending. The drunk at the bar just ordered another round of drinks to be put on his tab. Sooner or later the bartender is going to demand that he pay. Guess who’s going to get stuck with the bill? In the case of the European debt, another drunk at the bar is buying a round of drinks to be put on his tab. Somewhere along the line, the bartender better conclude that the drunks are all a poor credit risks.

  • GILLYSROOMS in Australia

    As long as the spending creates an asset of near equal value…then I cant see any problem with the spending, however the current bunch of politicians might not know what an asset is…Its always easier to spend other peoples money…if only we could ask all the Kings and Queens in old English history how they accumulated their wealth? Is anyone feeling like a poor peasant serf of the middle ages? Paying rent on your freehold lands and taxes on your corn and vegie productions…like a share farmer would maybe? Can anyone see the similarities …PRESIDENT = KING, CONGRESSMEN=LORDS, IRS =SHERIFF, GOVT BEURACRATS = KINGS FAMILY, POLICE = KINGS SOLDIERS, VOTERS= TAX PAYING SERFS. HISTORY is just repeating itself under another group of names. I’m sure other posters can create better examples and lets start a naming movement …perhaps a game like monopoly..using YES MINISTER titles too…anyone game to try?

  • GILLYSROOMS in Australia

    The only thing that is improving is its becoming a ‘normality’ AND people are still eating, drinking and be merry in Europe and its does not appear to be affecting their standard of living yet. The problem is still there but the bad news has lost it gloss as The World Bank or some unknown group have just created several $trillion in euro currency to keep the ship afloat a little bit longer…maybe until after the next USA elections?


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