Few things scare markets more than deflationary crashes such as the 2007-2008 Great Recession but sovereign default scenarios most definitely do. Why? Simply because the status quo in terms of public discourse revolved around sovereigns being foolproof for an extended period of time, with occasional “Twilight Zone” situations such as ultra-vulnerable nations like Spain (which puts the “S” in PIIGS, literally) being able to issue bonds that allow them to borrow money at rates similar to those paid by the US.
When times are good, the market doesn’t ask many questions.
And, indeed, prior to the Great Recession, things seemed to be going rather well over in the European Union. Economically vulnerable countries such as Greece (which, of course, didn’t consider itself economically vulnerable at the time) were able to tap into immense pools of capital thanks to the fact that they were European Union as well as Eurozone members and investors who thought such a nation could end up becoming insolvent would have been ridiculed.
Being able to access impressive financing can be a good or bad thing (blessing or curse, to venture into cliche territory), it all depends on what you do with the capital in question. Unfortunately, the so-called PIIGS nations (the term experts oftentimes used when referring to the so-called Eurozone periphery, with the countries in question being Portugal, Italy, Ireland, Greece and Spain) ended up frequently… well, splurging. Perhaps Greece is a textbook example to that effect, with it using the copious amounts of money it had at its disposal on anything from pretty much useless public works to organizing large-scale competitions.
Times were good and PIIGS citizens felt affluent.
After all: the homes they lived in apparently became more and more valuable, wages went up (including, as crazy as it may seem, the 13th and 14th monthly wage over in Greece), a lot was being built both by the private sector and especially the government (even if, again, they were frequently quasi-useless public works), times were without a doubt good.
Until… well, they weren’t.
As the Great Recession exposed various cracks in the proverbial system that markets were more than happy to overlook when profits (even if only in the form of unrealized gains… paper profits, if you will) seemed to be plentiful, investors came to the realization that some countries were actually in awful financial shape.
As such, nations such as Greece ended up losing market access, with frightened investors sending their hot money to safe haven assets such as US Treasuries, as spreads between US Treasuries and let’s say PIIGS bonds spiraled out of control. A bit of a perfect storm manifested itself, with results which ranged from massive unemployment (over 25% in Greece and Spain, with a youth unemployment level north of 50% in both cases) to having to resort to the International Monetary Fund as a lender of last resort.
However, the IMF doesn’t just blindly throw money at countries which lost market access and, instead, demanded that the countries in question undergo painful structural reforms. The proverbial party ended, with the average citizen being more than frustrated with the status quo and being on a constant lookout for scapegoats.
Once again, Greece represents a textbook example to that effect, with the two “traditional” political parties losing steam and various exotic presences popping up in their parliament, from the far-left SYRIZA to far-right groups such as Golden Dawn. The same way, the popularity of the EU itself and especially the Eurozone within the countries in question collapsed, paving the way for political actors to emerge who suggested warming up to nations such as Russia and China.
This finally brings us to China’s role in this entire equation.
Just like Russia, China managed to shrewdly speculate that cracks would start to appear within the EU and positioned itself accordingly. In Greece, it was SYRIZA which suggested that it would be a good idea to warm up to entities that don’t necessarily share Western values, whereas similar trends emerged in other PIIGS nations.
In light of its Realpolitik approach (as a bit of a tongue-in-cheek reference to Germany), China was quick to make it clear that under the right circumstances, PIIGS countries or any other EU nation for that matter could be on the receiving end of Chinese capital, with the massive infrastructure-related investment potential this tends to bring about.
Needless to say, Northern European countries such as Germany (creditor nations, if you will) were anything but happy with this status quo, with frustrations building up among their citizens with respect to the “reckless PIIGS countries” which squandered European funds and are now complaining to top it all off.
As time passed and the dust settled, however, things started getting back on track as far as the PIIGS nations are concerned, with economic growth ultimately returning and political actors such as SYRIZA losing their luster. However, it is worth noting that this came at a dramatic expense, with the European Central Bank for example having to bring interest rates into downright negative territory as well as inject more capital into the system at the height of ECB QE than the Federal Reserve did at the height of US QE.
To put it differently, the proverbial can has simply been kicked down the road, with many structural problems associated with PIIGS nations remaining a threat, but a threat that most of the (geo)political actors involved are more than happy to sweep under the rug as long as the market plays along.
What would happen in the event of a rug pull?
Needless to say, the various systemically relevant problems that have been left unattended would resurface with a vengeance, with China hoping that it manages to be on the receiving end of various trade-related benefits which might come as a result of the political backlash that would follow a (new) PIIGS sovereign debt crisis. As always, the ChinaFund.com team will be keeping its ear to the ground and is happy to share its findings with readers and especially clients.