International Financial Management the Sovereign Term Paper

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Total Length: 2451 words ( 8 double-spaced pages)

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257%

Greece

12.514%

Ireland

Baa1

9.384%

Spain

5.119%

Portugal

A3

7.497%

The structural issues that underlie the crisis remain unresolved. The austerity measures that have been implemented have failed miserably to restore business confidence -- they are crippling any economic recovery and have not given investors any reason to be confident about resolving the long-run debt problems faced by any of the peripheral Eurozone nations. The specter of increased Eurozone interest rates to meet the needs of Germany will only hurt the recovery of the peripheral economies further. As a result, a resolution of the sovereign debt crisis in the Eurozone does not appear to be on the horizon. Economists have made a number of proposals for the resolution of the crisis, none of which appear to have any political traction: a single Eurobond (De Grauwe & Moesen, 2009); addressing the divergence between Euro-level monetary policy and sovereign-level fiscal policy (De Grauwe, 2010), tighter controls from the European central bank (Maurer, 2010); and better understanding the linkages between rating agency pronouncements and market responses (Arezki, Amadou & Candelon, 2010). The implication of the wide variety of equally untenable solutions is that this crisis will continue to manifest over the near-term and there is significant risk that long-term solutions will not be forthcoming either.

Investment Advice

The Eurozone crisis has been characterized by lower prices and higher yields on the sovereign debt of most peripheral Eurozone nations. CDS spreads over German debt have increased, and German debt is seen as a safe haven within the Eurozone. Yet the long-run structural issues that have resulted in this crisis remain unresolved and are likely to remain so for the foreseeable future. The maintenance of the status quo will have a few different effects that should be taken into consideration. The first is that in the current situation is essentially a death-spiral for peripheral nations in that higher cost of debt makes it more difficult for these nations to resolve their debt crises. Unless the crises are resolved by Germany and the European Central Bank, the situation will only get worse.

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The second consideration is that the ratings agencies are likely to continue to downgrade and revise their positions on Eurozone sovereign debt. These moves lag the market, which is viewed as having perfect information, but there is an irrational reaction to rating agency moves as well. This reaction is the primary cause for the spread of difficulty from one nation to the next within the zone. Speculation and irrational behavior do provide for investment opportunity, but only if it is believed that the markets will return at some point to the rational point of equilibrium.

It is recommended therefore that the Eurozone sovereign debt market be avoided for the time being. There is essentially no reason to have confidence that the long-run issues leading to the crisis will be resolved, and even the tangential contributors like the ratings agencies have not had their negative contributions curtailed. The nature of the Eurozone means that these issues are going to be contained within the zone, so non-Euro debt in the region can be evaluated independently. Indeed, nations outside of the Eurozone have significantly more flexibility in dealing with budget problems that nations within the Eurozone. Sovereign debt from outside of the Eurozone should be evaluated on a case-by-case basis. Even German debt, which is viewed as safe haven within the Eurozone, is not recommended at this time. Germany will ultimately suffer as the result of this crisis. Either German taxpayers will need to bail out the peripheral nations in order to maintain the stability of the common currency or Germany will need to face higher inflation in order to equalize inflation rates between it and the other Euro states. In either case, no nation within the Eurozone can expect to escape the impact of the debt crisis, as the markets conflate the crisis of one country with issues of all other countries within the zone, in large part because of the interdependency created by common monetary policy. Thus, it is recommended that all sovereign debt from the Eurozone be avoided until the structural issues that underlie.....

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