The great swap

by David Taylor

The biggest debt restructuring program in history took place yesterday. Around 85 per cent of private Greek bond holders decided to cut their losses and take a 53.5 per cent haircut on the value of their investments. That’s what the headlines tell you at least. In actual fact, they’re really swapping their debt for other debt worth around a third of the value of the original debt. It’s a raw deal whichever way you spin it.

In basic terms, the private sector had given the Greek government a whole bunch of money. Through economic miss-management, the Greek government is unable to pay those investors back. The country is insolvent. Instead of an outright debt default though (which is too politically messy), Greece has conveniently arranged for all those investors to get only some of their money back. It’s a strange world we now live in. An obvious moral hazard comes up here but the situation is so dire that different rules are being created for different situations. The simple aim of course is to prevent financial panic that would result in a complete global credit crunch.

So what next? Well the markets have already started to look beyond Greece to other countries in the firing line - namely Italy, Spain and Portugal. Debt markets in those countries will be watched very closely over the next few weeks and months. The fear is that money printing, controlled debt defaults, and bailout packages will become the norm… until of course the economic implications of such policies become untenable. At that point you don’t have a crisis, you have a depression.

We also had news this week that China’s economic growth is expected to slow to 7.5 per cent this year. Data on Friday also showed that retail sales, fixed asset investment and industrial production all fell around 2 per cent -not great news considering Australia relies on China to grow at anything north of 5 per cent to avoid recession. The good news is that inflation has also come down. Now that may indicate more underlying weakness in the economy, but it also provides plenty of scope for the People’s Bank to cut interest rates. The share market certainly took that as a positive on Friday afternoon.

There is no doubt though the rubber is hitting the road. GDP growth in Australia came in half what was expected, and the country produced a trade deficit with the sharpest drop in exports seen in almost 3 years. It’s clear the subdued international backdrop and the higher Australian dollar are producing a dampening effect on the economy.

It’s now all too clear that Australia, as a small open economy, is not immune to the international macroeconomic narrative being played out as we speak. Policy makers need to stay alert.

David Taylor

Disclaimer

The content in my blog is non advisory, please do not interpret this as advice in any way shape or form. These are just my thoughts and nothing I say should be acted upon.