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(Kevin Van Paassen)
(Kevin Van Paassen)

ROB Explainer

Brian Milner explains the Greek debt crisis Add to ...

Because the U.S. dollar for all the problems that the Americans have, remains the safety net of choice. And the first thing investors do when they're worried about another market or currency is rush to U.S. bonds. The U.S. has never defaulted on a bond in its history, it still has the world's largest economy, it's recovery is actually stronger than a lot of people thought and when push comes to shove, people still feel safe with those greenbacks. and the fact is that the Americans have severe fiscal problems, but as long as other people are willing to own their debt, they'll always be able to finance their way out of this mess and that's something not available to a lot of these sad European countries.

How and why is this crisis spreading to other countries? People are referring to it as a contagion.

They're even calling it an Ebola virus. It spread because once investors begin to lose confidence, it quickly mushrooms, so for instance, say you're buying bonds denominated in euros issued by Greece, and you don't want those bonds any more. Then you say, well, if Greece is having this problem, who might be next?

And clearly the next weakest country in the euro zone is Portugal, so suddenly there's a run against Portugal, and nobody wants Portuguese bonds -- they don't want to be the last person holding a dicey euro bond, so what do they do? They abandon the weaker bond issuers, and if they still want to hold euro bonds, they'll go to Germany which is the strongest economy in the region, and they'll buy German bonds. That gives them the euro exposure they might want in their portfolios without the risk that they perceive. In fact, what has happened is they've even been abandoning those. They've been rushing back to U.S. bonds and moving into Swiss bonds.

These are the traditional safety nets, they've been buying gold again -- that tends to happen, and it's really a crisis of confidence and it's hard to arrest that crisis without dramatic action and the problem in Europe is that they're been dithering.

It was described by one Greek commentator as the European union pushing the button but knowing it wasn't connected to anything. And what they did was say to the world, we will make sure Greece is okay, and you don't have to worry -- we'll put up the money necessary to keep the Greek government afloat, and by implication pay all its debts to bond holders. Well, if that had worked, the market was saying, great, the money's going to be there, I'm going to keep buying European bonds... But it didn't work, which means they weren't able to arrest the crisis of confidence by doing nothing, which is what they wanted to do.

Now they actually have to do something and the bond market looks at this and says, well, they're really not moving very quickly, considering that now I'm facing junk bonds on one side and devalued bonds from other countries, what is going on? Well, as that process drags on, investors in those bonds say, I have to get out of this because this is only going to get worse, and if they're dithering this much about helping Greece, what happens if Spain implodes? Spain has very high unemployment right now -- they've got a youth unemployment rate that rivals south Africa. What happens if Spain suddenly needs billions more to keep its social safety net from unravelling? Those bonds are going to end up junk too, so they say, I better sell them now and get into something safer and that's the contagion, and unless they treat the virus at the source dramatically with really strong medicine, this is what happens.

Is this a rational response by investors?

Well, markets are not rational, and neither are many investors. But it depends. There are people who profit in markets like this. Truly rational people who weigh the risks very carefully and say, I can get a yield on Spanish bonds, that is just terrific, and my risk might be limited by a hedge I might be doing somewhere else and that makes for a good investment, but if you have no stomach for that risk, then rationally you should be out of those markets, and right now, rational investors should not be pouring money into Europe, because the situation is in flux. We don't know what the solution's going to be and we don't even know if the solution will be enough to fix the problem. We know the problems are going to get worse, not just for Greece, but for Portugal, for Italy, for all of the really debt-laden countries and Britain too. Britain has its down currency, so they can do a little more on the monetary side, but their problems are really severe and you don't see any of the people who are running for office saying we've really got to bring in tough, tough austerity measures to fix this problem and that should worry bond holders, because governments that won't impose austerity are going to be back borrowing more and more money and that devalues existing debt.

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