Tag Archives: PIIGS

Mamma mia! What a week it’s been in the currency markets. Let’s get right to it.

Italy dominated much of the ink last week as its prime minister announced his resignation because of the country’s debt crisis. Prime Minister Silvio Berlusconi stepped down Nov. 12 after Italy’s government passed crucial economic reforms demanded by the European Union. He was replaced by economist Mario Monti, who’s serving as premier-designate. Aside from Berlusconi facing scrutiny for scandals and failures during his service, Italy is in fiscal turmoil because the country’s debt is larger than the combined economies of Portugal, Ireland and Greece. Not to mention its bonds are shattering the 7-percent level, worrying financial officials as the world’s eighth largest economy could potentially spawn an unmanageable economic situation. There was some good news for Italy Nov. 14 when it sold some short-dated bonds via a sale that had been viewed as “a key test of demand for Italian debt.”

In Greece, the country named former European Central Bank Vice President Lucas Papademos as its next prime minister, hoping his experiences can help right Greece’s economic ship. Despite the turnover of Italy and Greece, nearly 80 percent of Germans believe both the euro will survive and Chancellor Angela Merkel is handling the economic crisis well.

In the U.S., hedge fund experts are already betting that 2012 will see more investors and shopping around for investments. According to the 2012 Preqin Hedge Fund Investor Review, 10 percent of investors plan to invest only with new managers in the new year while nearly 50 percent intend to seek new relationships. Unfortunately for U.S. retail foreign exchange traders, some new rules and strict enforcements are causing some trading restrictions. According to a LeapRate report, currency traders have shrunken to their lowest levels in years because new regulations and legislation such as the Dodd-Frank act that have limited trading and the amount of leverage brokerages can offer individuals. On the jobs front, September saw the most job openings in three years as employers advertised more positions during the month. Many experts are hoping that’s a sign companies may increase hiring. The U.S. Labor Department said businesses and governments posted 3.35 million job openings—a 7-percent increase from August and the most since August 2008. Some more optimism for U.S. jobs last week included the number of jobless claims dropping to 390,000—well below the 400,000 mark that analysts expected. Additionally, the U.S. trade balance deficit reported below expectations, hitting 43.1 billion—also well below the expected 46.1 billion. To finish positively, and celebrating the recent New York City marathon, successful long-term investors are being compared marathoners because “they must be well prepared, resilient, disciplined and focused” to go the distance.

 

 

-------

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

When most people—at least us here at Currensee—hear Italy, we associate the delicious food. Because we’re located footsteps from Boston’s historic North End, the scrumptious smells of cannolis far too often waft into our office. After all, as Dean Martin croons, that’s amore.

While sweeping seascapes of the Amalfi Coast may race into your head as you swirl your pinot grigio, things in the boot-shaped country haven’t been a bella vista. Because of the European economic crisis, Prime Minister Silvio Berlusconi said Nov. 8 he would resign his prime ministership after parliament passed urgent budget reforms. During his service, Berlusconi also faced strings of humiliations, scandals, defeats and failures.

Aside from Berlusconi’s resignation, Italy is in fiscal turmoil as the country’s debt is larger than the combined economies of Portugal, Ireland and Greece. Experts worry that the Italian economy, the eighth largest in the world, will fuel a potentially unmanageable economic situation because its bonds are shattering the 7-percent level to a new high. As history showed, once Italy’s fellow PIIGS nations—Portugal, Ireland and Greece—surpassed 7 percent, their borrowing costs increased and eventually caused them to seek bailouts.

With a history dating back to Charlemagne’s reign in the late 600s and early 700s, the lira’s (lire for plural) official users are Italy, San Marino and the Vatican City. This is our third post in our new series about “currency culture,” where we examine the history of different world currencies and how they play a role in popular culture (read our previous posts about Greece’s drachma and Switzerland’s franc). With an introduction as stylish as a fashion runway in Milan, here are some interesting facts about the Italian lira:

  • Form of currency from 1861 to 2002, including during the Napoleonic Kingdom of Italy between 1807 and 1814
  • From 1999 to 2002, lira was a national subunit of the euro
  • Banknotes available in 1,000₤, 2,000₤, 5,000₤, 10,000₤, 50,000₤, 100,000₤ and 500,000₤; coins available in 5₤, 10₤, 20₤, 50₤, 100₤, 200₤, 500₤, 1000₤
  • Banknotes feature prominent Italians such as artist Raphael, composer Vincenzo Bellini, physicist Alessandro Volta and physician and educator Maria Montessori
  • Lira issued by Banca d’Italia, Italy’s central bank headquartered in Rome
  • Major renovations and restorations to the Coliseum between 1993 and 2000 cost 40 billion lire
  • The traditional Italian children’s song “Mamma Mia, Dammi Cento Lire” means in English “Mom, Give Me a Hundred Pounds”
  • Jimmy Lira is a character in the 2009 video game “The Godfather II,” based on the 1974 crime drama “The Godfather Part II”
  • Her first taste of fame at age 14, actress Sophia Loren was crowned a winner in a beauty contest that included a prize of 23,000 lire
  • Late fashion designer Gianni Versace in his will left his partner Antonio D’Amico a pension of 50 million lire a month (for life)
  • Retired Italian soccer player Robert Baggio in 1990 was sold to the professional soccer club Juventus for 15 billion lire

You may be lir-y about Italy’s current state of politics and economics, but the lira’s history might be just as intriguing as the catacombs of the Vatican and waterways of Venice. If you’re still lucky enough to have the currency, holdfast to it and don’t make him an offer he can’t refuse.

-------

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

The first golden age of globalization that spanned more than four decades from the late nineteenth century onwards, came to a shuddering end on June 28, 1914, when an unknown Serbian, Gavrilo Princip, forged himself a permanent place in history, when he assassinated Archduke Franz Ferdinand, the heir to the Austro-Hungarian throne, in Sarajevo.  The actions of Princip and his ‘Black Hand’ revolutionaries precipitated a war across the European continent that achieved little but the deaths of countless fighting men.

Unfortunately, the so-called ‘war to end all wars’ did not match its billing and, the conditions enshrined in the Treaty of Versailles and, subsequently imposed upon a defeated German nation, virtually ensured another depressing chapter in Europe’s bloody history.  Needless to say, the harsh programme proved self-defeating as, a downtrodden people in their search for leadership amid the chaos, propelled Adolf Hitler and his henchmen to power.  There is no need to expand on their drug-fuelled exploits.

Fast forward to today and the roles have been reversed.  The Germans, under the helmship of Chancellor Angela Merkel, wish to impose their will upon the rest of Europe but, what is demanded is neither achievable nor desirable given the unacceptable social costs.  One need look no further than Greece to see the destruction that is a direct result of the austere policies imposed by the troika and endorsed by Merkel – the outcome, it is fair to say, is a failed economic state.

The demands placed upon Greece were never likely to work and basic arithmetic said as much.  A high marginal propensity to consume that is moving lower as desired savings rates edge higher, combined with a low marginal propensity to import and uncompetitive export base means that the aggressive fiscal consolidation was doomed from the outset.  All told, the medicine prescribed has killed the patient.

The world’s capital markets will move on of course and, investors will almost certainly have Portugal in their sights, as the deep-seated problems in that economy don’t look much better than Greece.  Meanwhile, Ireland has decoupled from its troubled brethren in the euro-zone and not simply because of any public sector achievements but, a return to current account surplus and less dependence on foreign sources for financing.

Be that as it may, the turnaround in the Irish situation is wholly dependent on no recession across the euro-zone from here to infinity.  Non-financial private sector debt as a percentage of GDP accumulated to obscene levels in this country, under the watchful gaze of those who should have known better and, still remains off the charts compared to the rest of the developed world – despite the aggressive deleveraging that has already taken place.

Unfortunately, a European recession is almost certainly written in stone at this juncture.  Dithering by policymakers, who seem incapable of distinguishing between liquidity and solvency crises, has undermined market confidence to such a degree that the resulting financial market stress is almost certain to produce the dreaded double-dip.  More to the point, recent data releases all suggest as much.

A further downturn in economic activity, before the region even comes close to recovering its pre-recession peak, could well put an end to the European project.  Even before a recession is considered, back-of-the-envelope calculations indicate that Greece will not recoup its lost output for ten years and, both Ireland and Portugal should not expect to see expansion from former glories until the second half of the decade.

Of course, those predictions are predicated upon a ‘softly-softly’ upward trajectory in each individual economy’s fortunes.  It is safe to say that such an approach rarely matches the subsequent reality and, will ultimately prove to be fantasy in the context of an all but certain downturn.

The crux of the matter is not a renewed downturn of itself but, the unacceptably high levels of unemployment to begin with and, particularly among the young.  The latest reading on unemployment rates across the euro-zone is hardly pleasant reading at ten percent but, youth unemployment can be described as nothing less than a social tragedy and, fiscal consolidation programmes across the region as endorsed by Germany, will almost certainly make matters worse.

Digest the numbers but be warned, they are not pretty.  The latest readings show that the highest rate of youth unemployment begins with Spain at 45 percent and, then Greece at 43 percent. Ireland, Portugal and Italy hug closely behind with levels close to 30 percent.  No matter what economic leaning one comes from – left or right – these numbers are unacceptable.

The euro stands at a crossroads but, no matter what is accepted by the yellow-bellied politicians that yield to German demands, nothing can escape the fact that such prescriptions have already delivered one failed economic state.  Be warned, Ms Merkel, Europe’s future may well be decided on the streets.

Previously posted on www.charliefell.com

 

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

The downward pressure on world stock markets, that began some months ago, continues to grow in intensity, as rising recession risks across the Western world can no longer be ignored.  The source of the turmoil has moved back-and-forth across the Atlantic Ocean in recent months, as a lame economic recovery in the US has collided with a debt crisis in the eurozone.  Indeed, the focal point for the latest bout of turbulence centers on Greece and its government’s inability to meet the ambitious targets as prescribed under the EU/IMF adjustment program.

Unfortunately, the focus on Athens has seen most commentators, investors and, even policymakers view the eurozone’s problems through the narrow prism of sovereign debt.  Viewed in this light, profligate government spending precipitated the build-up of sovereign debt to unsustainable levels and, as a consequence, many analysts seem to believe that successful fiscal consolidation in the troubled nations of Greece, Ireland and Portugal, will bring the crisis to an end.

Such a belief however, is extraordinarily naïve as the crisis should be seen, not as a sovereign debt crisis, but more appropriately as a balance of payments and external debt crisis.  The availability of low-priced credit from banks in the eurozone’s core following the launch of the single currency more than a decade ago, allowed the periphery to run large and persistent external deficits that sparked a disturbing increase in the level of foreign debt, both public and private.

The dependence on foreign debt made each of the peripheral nations vulnerable to a sudden reversal in capital flows.  A reassessment of risk premiums, as the ‘Great Recession’ took hold, led to a stunning increase in interest rates and one-by-one, the governments of the peripheral nations had no option, but to seek assistance.

However, while fiscal consolidation as prescribed by the EU/IMF adjustment programs may well be desirable and necessary, the reversal of primary budget deficits alone will not be sufficient to bring the crisis to an end.  The large current account deficits still present in Greece and Portugal in particular, must be eliminated if foreign debt loads are to stabilize but, in the absence of currency devaluation, that task looks nigh on impossible.

Foreign lenders in their search for yield in a low-return world, lent freely to the peripheral countries in the years leading up to the crisis.  Current account deficits were allowed to grow to alarming levels with little, if any, consideration for the true nature of the risks involved.

The Greek external deficit relative to GDP expanded by more than eight percentage points to almost fifteen per cent from 2003 to 2008; the Portuguese deficit widened by more than six percentage points to 12.6 per cent over the same period, while the Irish external position went from near-balance to a deficit of 5.6 per cent over the five-year period.

External imbalances were to be expected following the launch of the single currency, as relatively poorer countries played catch-up with their wealthier brethren.  However, borrowed funds were used primarily to finance current consumption, rather than productive capital investment designed to boost export potential, such that a significant proportion of the foreign lending may never be repaid.

The focus on sovereign debt is understandable in the case of Greece, since it was its unsustainable public debt position that sparked the confidence crisis.  Nevertheless, the country’s non-financial private sector debt ratios still managed to jump from 52 to almost 90 per cent of GDP between 2002 and 2009, as underleveraged Greek households and businesses caught the borrowing bug.

The Portuguese private sector partied that bit harder and the comparable debt ratio surged by more than 50 percentage points to 178 per cent over the same period, while the non-financial private sector in Ireland outdid everyone with the ratio increasing by more than 100 percentage points to almost 200 per cent.

An external financing crisis duly erupted in each country, as the borrowing capacity of both private and public sectors reached exhaustion with net external debt approaching 100 per cent of GDP.  Focus on such disturbing external imbalances was bound to happen sooner or later, irrespective of what happened elsewhere, though the meltdown in America’s mortgage market brought matters to a head sooner than might otherwise have been the case.

The fall-out was severe though hope springs eternal, as the Irish situation has since stabilised. A large trade surplus has allowed the current account to move into positive territory and, not surprisingly, yields on Irish debt have decoupled from their troubled brethren.  Be that as it may, a successful conclusion to the Irish problem hinges on events elsewhere.

Unfortunately, the news from both Greece and Portugal remains grim.  Chronic trade deficits persist in both countries, while foreign debt and interest payments abroad continue to grow.  A large double-digit percentage point reversal in the trade account as a share of GDP is required to stabilise the level of foreign debt in both cases.  Such a development is highly unlikely given the low value-added and uncompetitive nature of the respective export sectors, not to mention the slowdown in external growth.

Absent a herculean reversal in the export sector’s fortunes, the necessary external adjustment could only take place through a depression-like collapse in domestic demand, which would throw fiscal consolidation off course and result in no fall in aggregate debt levels.

Both Greece and Portugal are stuck in a debt-deflation trap and the harsh reality cannot be disguised – both countries are insolvent.  Eventual euro-exit should not be dismissed lightly.

Originally posted on www.charliefell.com

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Greece is recognized internationally for its architectural marvels such as the Acropolis, but the European country may be more currently known for its recent economic instability, looming on the brink of default. As the European debit crisis continues to broil, discussions swirl about whether or not to return Greece to its former currency – the Drachma – that financial officials say would allow market forces to set the country’s wage levels. Portugal, Italy, Ireland, Greece and Spain – Europe’s PIIGS nations – have felt the most painful tremors of the crisis, and the economic powerhouse of Germany has been whistled in to bailout weaker nations.

Despite the trouble, the Drachma has a rich history that has spread throughout the Hellenistic world and the influences of Alexander the Great. This is our first post in our new series about “currency culture,” where we’ll examine the history of different world currencies and how they’ve played a role in popular culture. With an Olympic-sized introduction, here are some interesting facts about the Drachma:

  • In the beginning, the drachma was a handful of six metal sticks used as a form of currency as early as 1100 BC.
  • Reintroduced in 1832, replacing the phoenix after the establishment of the modern state Greece.
  • Derived from the Greek word drássomai, which means “to grasp.”
  • Also a small unit of weight.
  • Large round coins made of gold or silver.
  • Symbols include Δρχ., Δρ. or ₯
  • Embossed with images of various Greek Gods.
  • There was a 1981 episode of “The Fonz and the Happy Days Gang” called “The 20,000 Drachma Pyramid.”
  • In the “Percy Jackson and the Olympians: The Lightning Thief” video game (based off the 2010 fantasy film), drachmas aren’t used as currency, but instead as equipment for characters. There are 20 drachmas for collection in the game.
  • In 2002, the drachma ceased because of the euro’s introduction.

For some hope that the Euro crisis will be solved soon and Greece will regain momentum, we can remember some wise words from Aristotle. “It is during our darkest moments that we must focus to see the light,” the great philosopher said.

-------

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

In the United States this week, we were twisting and shouting like a 1960s disco track, while Italy wasn’t feeling the amore from financial officials and Greece wasn’t succeeding in its Olympic financial fiasco. Here are the top posts from last week:

The markets were expecting the Federal Reserve to announce Operation Twist, in which the Fed would sell short-dated Treasury debt and use the proceeds to buy long bonds. The Fed initiated a similar act in the 1960s, but with today’s numerous economic uncertainties – high unemployment rates and consumer debt – this small step is unlikely to create much spending. While America grappled with its monetary quandaries, Europe tried sorting its financial flounders. Standard & Poor downgraded Italy’s credit rating, saying arrivederci to the country’s A+ grade and ciao to its A mark with a negative outlook. Across the Adriatic Sea, Greece was also continuing to experience its continued economic pounding as it straddled the brink of default. The European Union

commissioner has said “the EU will not abandon Greece or let it default uncontrollably.” France is planning a 10 to 15 billion euro recapitalization plan for five top banks combating the debt crisis, causing a formal denial from financial ministries. The ministries said the government held discussions with leading banks about their state of heath, but denied bailout offers. One top financial executive said “French banks have a sufficient capital base compared to other European banks and they are making profits.” Also in Europe, the Swiss bank UBS’s chief executive resigned Sept. 24 after a $2.3 billion rogue trading loss. Oswald Greubel’s resignation ends days of speculation about whether or not he would retain his top post among one of the biggest scandals to hit the Swiss bank.

-------

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Trade Leader Outlook blog post written by Currensee Trade Leader, Spencer Beezley.

August is usually a difficult month to navigate for currency traders, and this August was no exception. There are a lot of issues in the world that have yet to be sorted out and traders are having trouble determining the lesser of "two evils" so to speak. On one side, you have the USA and the downgrade in credit rating and debt issues, and the lack of decision making by the FED on what to do next. And then Europe with the PIIGS and the Eurozone crisis and all the things that need to be sorted out there. This confusion was evident in the market by looking at the lack of direction the EURUSD took in August. Some volatility was evident, but the market experienced a sideways range that couldn't breakout of the 1.45 and 1.40 levels, which were tested but never significantly broken through. Now after the first full week of September, the Dollar rallied and broke that 1.40 level and is starting to gain traction against the Euro. We might see some retracement back to the upside but we need to keep an eye on all the numbers and the key technical levels to determine if this will develop into a longer term dollar rally or false movement. Watch for the fundamental developments of strong decision making in Europe and the ECB, or the Fed in the USA.

My plan for the market:

I am a firm believer in sticking with the strategies that I've had success with. However, sometimes traders get in trouble by not paying attention to certain factors in the market that could negatively affect their strategies. Since August was not a month of breakouts, we have to closely monitor price action and key technical levels of market support and resistance, as well as daily range. In August, I found that many of my targets were not reached, because of the ranging nature of the market, which is why I have exit strategies set up in case of a reversal and I certainly don't want a winning trade to be turned into a losing trade. Also, make note that I use a tight stop loss on my trades, so there may be some losses, but they are cut short in order to protect equity and to provide a solid risk/reward ratio.

One of the things that is important is to not over-trade. With my strategies, some weeks will be lighter on volume than other weeks just depending on what the charts look like. Some traders try to avenge losses immediately or during an open floating loss. This is a setup for failure as it is best to wait until the next valid trade opportunity and not to trade off emotion. In August, I noticed that the market wasn't ideal for one of my strategies, so as a result, I stopped trading that strategy until the market gets back to a place where I feel comfortable re-implementing that strategy.

Going forward through September, I am hopeful that the market will have a higher daily trading range and I believe that more valid breakouts and trends will form as traders begin to get a better feel for this current market we are faced with, and how the economies and currencies will be affected. I am also a true believer in technical analysis and stop trying to predict what is going to happen with an economy, rather let the fundamental developments play out which will all be translated into the technicals, chart patterns, and price levels of the currency in which we can base our trades and strategies from.

With chaos and confusion often comes opportunity. I am a firm believer in trading where there's a trade and holding off if the market isn't there. September's rally out of the gate is a positive trend that I'm ready to ride.

To download Spencer Beezley's Currensee Trade Leader profile please click here.

A question came in from an attendee of last week's PIIGS panel discussion which wasn't directly related to the topic at hand, but which is clearly something that's on forex traders' minds these days. The question was "Is there a chance Dodd-Frank bill could end retail FX in the U.S." This is something I wrote about on my own blog last week, but I'll address it here again because it's something, which clearly needs further comment.

To answer the question very directly and succinctly, there is absolutely zero chance Dodd-Frank kills US retail forex.

That direct enough? :)

This question perhaps could have legitimately been asked a year ago when the bill was passed, but to bring it up now is useless. Basically, what Dodd-Frank said in regards to retail forex in the US is that the overseeing regulatory agencies must put regulations in place within a state period of time (a year I believe) or a prohibition would be put in place. The reason this has come up recently is that an SEC ruling came out which basically said (in order to meet the Dodd-Frank deadline) that existing rules regarding retail forex trading would stay as they are for a year while the agency considered new rules.

The fact that this SEC news has caused consternation in the retail forex trading community reflects the lack of understanding of how the market is regulated in the U.S. The SEC is only responsible for "securities" firms, which basically means stock brokers and stock exchanges. That means there are only a couple of minor forex players (and would-be players) falling under SEC purview.

The CFTC is the major regulator for retail forex trading in the US. The vast majority of forex brokers serving US customers are registered with that agency. The CFTC has already put through new rules. In fact, it was in the process of doing so even before Dodd-Frank. They didn't kill the US retail forex business then, even though there were loads of voices screaming that the FIFO, no-hedging, and 50:1 leverage limitation changes would do just that. The business is alive and well and not going anywhere.

I actually think the SEC could only really have a positive impact on US retail forex trading. The worst the agency could do is ban it for securities firms all together, but that's not something that's going to have any real impact on the industry because of the small footprint of stock brokers. If the SEC went the other way, though, and put the stock brokers in some kind of favorable position relative to the CTFC-regulated firms (or at least didn't put them in a disadvantaged position) it could actually create more positive competition in the industry.

2 Comments

With the reported deadline for getting the US debt ceiling raised only a couple weeks off now, the question of what to expect and how the markets can be expected to react are common ones. Yesterday, Treasury Secretary Geithner made clear his expectation during an interview on CNBC. When asked about what Plan B would be in case Congress did not come through with a raising of the debt ceiling in time to meant the deadline he said there was no Plan B, that the debt ceiling would get raised.

Personally, I agree with the Secretary Geithner. We're going through the typical political theater that happens whenever something like this is to be decided. Both sides need to make their stands to demonstrate their convictions to those who vote for them. In the end, something will get done. No doubt it will represent a major compromise for both sides and not really be as big a deal was what's been talked about, but that will offer both sides the opportunity to blame the other while stumping on the campaign trail.

Judging by how the markets are trading, I'd venture to say they are in agreement with me. No default has been priced in. If it had, we'd be looking at Treasury rates closer to those of some of the PIIGS. That, in and of itself, is a major motivator for the politicians to get something done, as adding a few hundred basis points to 10 year Note yields would have a comparable knock-on effect to the likes of mortgage rates at a time when higher borrowing costs isn't going to do the economy any good at all.

Even if the debt ceiling doesn't get raised on time, it wouldn't necessarily mean a government default on Treasury debt. They could still make those interest payments (and roll-over the principle) while cutting spending in other areas. This isn't an attractive option (though some seem to favor it), but it's doable if required.

So what would happen if the Treasury did default? Chaos, in a word.

It would start with the ratings agencies cutting the US AAA rating. That would cause many portfolio and fund managers to have to get rid of Treasuries because of the requirements they have to hold only certain quality paper. It would also impact on numerous municipalities who have debt guarantees from the federal government (e.g. Build America Bonds). The same would be true of agency (Fannie, Freddie, etc.) debt. Foreign holders of Treasuries (China and Japan hold over $2trln) would likely be motivated to cut their positions as well, and the Fed may be forced to liquidate its holdings also, either for technical or policy reasons. That's a lot of selling, which would drive rates rapidly higher. And of course all of this would no doubt really do a number on the dollar.

And on a kind of theoretical basis, what would be the risk-free rate if the US rating were dropped? For years finance researchers have used Treasury rates to represent the risk-free rate in their calculations. What, if anything, takes that place?

In other words, were the US to default (and thus lose its AAA rating) it would likely mean a complete upset of the global financial system. You can be sure the politicians know how bad things would likely get (having been told repeatedly by Fed Chief Bernanke and Secretary Geithner, among others), so they will be very motivated to make things happen, one way or another. The markets know this, which is why T-Bills having single-digit yields and 10-year Note rates remain below 3%.

As promised here is Part 2 of our interview with PIIGS panelist Charlie Fell. Charlie will be joining us on Thursday for our live webinar discussing the Eurozone debt crisis.

What country would a Greek default affect the most and why?

Contagion would be immediate to Portugal and Ireland, as investors would immediately speculate that the two troubled nations would follow suit.  If the default was disorderly, it could prove impossible to prevent Spain and Italy from being dragged into the quagmire.  Loan losses would also be an issue – the write-downs would bankrupt the Greek banking system and blow a large hole in the balance sheets of French, German and Portuguese banks.  A full-scale financial crisis across the euro-zone and the globe could erupt.  The fear that a Lehman-style meltdown lies in wait is very real.

The Eurozone is typically painted in a bad light, in terms of the USA - how do they measure up?

Public debt has increased at a faster pace in the U.S. than the euro-zone in aggregate and the debt-to-GDP ratio is ten percentage points higher in the former than the latter.  However, unlike the U.S., the euro-zone is not a fiscal union and thus, an individual country with large external debt in euros is much the same as an Asian country that fixes its exchange rate to the greenback and borrows in dollars.  Just as several East Asian countries collapsed in the late-90s when external financing stopped, the same would have happened to Portugal, Ireland and Greece, but for the support of the ECB who have kept the respective banking systems afloat.

Can you explain the relationship between Greece and Spain and how supporting one may mean no funds for the other?

The further support of Greece reduces the available lending capacity of the EFSF, which currently stands at about €320 billion.  This is not sufficient to cover Spain’s financing needs over the next two years, so European leadership must take credible action to contain the crisis, before it spills out of control.

What would happen if one of the PIIGS countries dropped out of the Euro?

Such an outcome is still unthinkable at this juncture, as it would almost certainly precipitate a financial crisis.  It is important to remember that euro membership is effectively irreversible, as exit would unleash the ‘mother of all financial crises’ on the seceding country.

Do you think Italy should be part of the PIIGS?

Italy has, from the euro’s inception, has been the so-called ‘elephant in the room’ given its high level of public debt, which is approaching 120 per cent of GDP, and is low trend growth at just one per cent.  However, the Italian economy does not possess the large macroeconomic imbalances evident in the periphery.  Private sector debt is low as too is the level external financing, the current account deficit is relatively modest at 3.3 per cent of GDP, and the fiscal position is moving in the right direction.  The primary fiscal deficit was close to balance last year and the Italians are expected to have the largest surplus across the euro-zone this year.  Furthermore, its banking sector has relatively little exposure to problem assets abroad.  Italy does not belong to the PIIGS, but unfortunately the markets may think otherwise.

-------

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.