[quote name='mykevermin']Thanks for the explanation. I was thinking that a higher % rate would be good for those who buy the bonds, but neglected to realize that the % increasing so high (since it's market driven) is the nation of Ireland having to respond to simply not getting enough people to buy bonds right now - the net result being that they're going to end up in a
load of trouble when they have to pay back those bonds.
That's about the thick of it, yes?[/quote]
Yup.
EDIT: Also that this inherently increases the risk of buying Irish bonds - reason being that a nice return rate correlates nicely with a higher default rate, meaning the prospective bond buyer stands to either get a good yield on their bonds, or go completely
ing bust. Yes?
Yes and no. There will be a point at which the cost of borrowing will be so high that they simply will not be able to repay. Then we end up (in Ireland's case) in front of the IMF and EU central banks. If the IMF and EU refuse to loan, then they would default and the process would look roughly similar to a bankruptcy. All debt holders line up and renegotiate for a % of the value of the bonds they hold. Since sovereign debt is considered among the safest investments you can make, buyers are often retirement funds, pension funds, "safe" investors that can't afford to lose capital. So when Argentina defaulted, it was countries that had these safe investors in the market that get screwed. For example, Italy was heavily invested and had a bunch of their pensioners eat shit on Argentina, so now it's Italy's problem too (in the case of Argentina, Japan, Germany, and Spain all took a big hit) and then it gets all crazy political.
This is why sovereign (ie actual countries) debt is considered so much safer than private debt. The chances that an external entity won't step in is much lower. Countries will lobby to prevent it, the IMF will step in, and the central bank can offer emergency loans. That's a helluva lot of pressure in the real world. The market knows all this and prices accordingly. No matter how jacked up a country is, it's still less risk than a private bond from even a quality company.
So you've got all this crazy downward risk pressure on sovereign bonds. We never actually "see" the true risk priced in, at least not normally. In America, as the conservatives like to say, we own the printing press (ie we have a central bank (ie the Fed)), which means we alone control our money supply. America can (and does) say "oh, we owe you a dollar. Hold on a sec. *fires up the press* Here ya go!" But Ireland doesn't have that ability because it's on the Euro. Their interests compete with all other EU central bank "clients", included Germany, France, countries that are doing fine (in a relative sense).
This is where it gets ugly for Ireland. Everyone wants to devalue their currency right now. It makes exports cheaper and since nobody is growing at home, everyone wants to drink everyone else's milkshake. China won't allow their currency to go up and has been drinking everyone's milkshake for years now. The EU and America want in on the action. The fear is that
currency wars will break out, where everyone devalues the shit out their currency to get lower than the next guy (a race to the bottom). In reality, devaluation is protectionism by another name and it'll grind international trade to a halt. So it becomes a game theorist's wet dream: take as many jenga pieces as you can without crashing the whole thing.
Ireland's bad shape lowers the value of the Euro. Germany LOVES this fact because a monstrous amount of their economy is export based and people can afford their crap.
There's a competing interest to Ireland's solvency. So Germany wants to stoke the fear of Irish default without them actually defaulting. And we can watch how it unfolds in real time. Last night around 2am Atlantic time, a rumor broke that Ireland was in talks with the EU on a bailout. Irish bonds immediately get stronger:
Remember, red = bad for investors, great for the bond issuer.
Germany goes oh shit! Can't have that! German Chancellor Merkel responds to the news:
She acknowledged her stance had scared financial markets, which have punished Irish, Greek and Portuguese debt for two weeks. It was unfair for European taxpayers to finance rescues of debt-laden countries on their own, she said at the Group of 20 summit in Seoul.
“Let me put it quite simply: in this regard there may be a contradiction between the interests of the financial world and the interests of the political world,” Ms Merkel said. “We cannot keep constantly explaining to our voters and our citizens why the taxpayer should bear the cost of certain risks and not those people who have earned a lot of money from taking those risks.”
You can see the change to the Euro when they thought Ireland was in bailout talks last night. Now Merkel hammers em. What does the Euro do on her words? Exactly what she wants:
And the morning consensus seems to be that Merkel is full of shit and they're going to bail them out. IF you believe they'll be bailed out and IF you believe they really do have their shit together, Ireland would be a nice buy. Those are mighty big if's though. It's like Germany is keeping Ireland on life support to keep getting Ireland's Social Security checks. It's so awesome to be German right now. Their politicians can blame everyone else in the EU for financial problems, and they get all the benefits of their problems at the same time. They can tell the rest of the world that their currency value is out of their hands, but they can carefully orchestrate the conditions that affect its value. And when Ireland and Greece (and Portugal and Spain) finally do get their shit together, they're going to be paying interest on loans from the EU that go back to guess who? Germany.
Germany "helps" Ireland's interest rates on their bonds go sky high. Ireland goes from 5% to 8.9%. Germany swoops in as the white knight and loans to them at 8% or 7.5% or so. Ireland thanks god that they don't have to pay market rates. Germany makes a tidy 2.5-3% above the rate the market had put Ireland on, which was based on Germany's actions.
This is the perfect example of a Keynesian destroying a Supply Sider. To paraphrase Aesop, the Keynesian ants store for the winter while the supply sider grasshopper enjoys the summer. Winter comes and the Keynesian loans to the supply sider at 8%. And the supply sider owes the Keynesian for the next decade or three.
