MacroScope

The debt crises in the euro zone and United States are claiming some innocent bystanders. Investors fleeing for the safety of the Swiss franc have ratcheted up pressure on Hungary, where thousands of households have watched with horror as the  franc surges to successive record highs against their own forint currency. In the boom years before 2008,  mortgages and car loans in Swiss francs seemed like a good idea --after all the forint was strong and Swiss interest rates, unlike those in Hungary, were low.  But the forint then was worth 155-160 per franc. Now it is at a record low 260 -- and falling -- making it increasingly painful to keep up repayments. Swiss franc debt exposure amounts to almost a fifth of Hungary's GDP. And that is before counting loans taken out by companies and municipalities.

Hungarian families could get some relief in coming months via a government plan that caps the exchange rate for mortgage repayments at 180 forints until the end of 2014.  But the difference will have to be paid -- with interest -- from 2015.  Meanwhile, the issue threatens to bring down Hungary's banks which must pick up the cost in the meantime and will almost certaintly see a rise in bad loans --  no wonder shares in Hungary's biggest bank OTP are down 25 percent this month.  "(The franc rise) suggests a massive jump on banks' refinancing requirements going forward, " says Citi analyst  Luis Costa.

These overburdened banks will end up cutting lending to businesses, meaning a further hit to Hungary's already anaemic economic growth. ING analysts earlier this month advised clients to steer clear of Hungarian shares, "given the burden from (forint/franc) depreciation not only on loan-takers but also the implications this has for the domestic growth story."

Thanks to some deficit cutting measures and low inflation, Hungarian bonds have been among fund managers'  favourites this year. Unlike countries such as Brazil or Poland, Hungary was not raising interest rates. Citi's Costa says longer bonds are still being too slow to price the risks -- he predicts  the 70 basis point spread between two-year and 10-year Hungarian swap rates will widen much further. And late on Wednesday, JP Morgan said it was going underweight Hungarian bonds. Analysts there suggest that at a time when other emerging markets are preparing to slash interest rates, the falling forint might force Hungary's central bank to do the opposite.

Europe’s debt problems had thus far been largely contained to the so-called periphery, places like Greece, Ireland and Portugal. But increasingly, doubts are rising about countries once seen as insulated — Spain, Italy, even Belgium and France.

Bond markets are not painting a pretty picture. Ten-year Italian and Spanish yields are now firmly trading above 6 percent — 7 percent is considered the point of no return, the level above which funding costs become unsustainable.

The yield gap between 10-year Belgian and German bonds hit a fresh euro life-time high earlier, as did France’s equivalent. Belgium’s 10-year yield spread traded above 200 basis points – lower than around 370 basis points currently on the Italian equivalent but up sharply from readings in the double-digits seen last year.

By Robert H. Frank
The opinions expressed are his own.

Reuters invited leading economists to reply to Lawrence Summers’ op-ed on his reaction to the debt ceiling deal. We will be publishing the responses here. Below is Franks’s reply. Here are responses from Laura Tyson, Benn Steil, Russ Roberts, Donald Boudreaux and James Pethokoukis as well.

I'm in general agreement with Larry Summers' piece. If it had been my column to write, I'd have been more emphatic about how much more important the unemployment problem is than the deficit problem. Deficits need to be reduced, yes, but not in the midst of a deep downturn. If we could put just half of the people who are either unemployed or underemployed back to work, for example, national income would be larger by more than ten times the interest we're paying on the 2011 deficit. The extra income tax revenue alone would be enough to cover the interest on last year's debt.

I'd also have hit harder on the claim by ostensible deficit hawks that extra spending right now would impoverish our grandchildren. Some of the most vivid and easily understood counterexamples involve infrastructure maintenance. According to the Nevada Department of Transportation, repairing a damaged 10-mile stretch of Interstate 80 would cost $6 million if we did the work today. But if we postpone repairs, weather and traffic will continue to damage the roadbed. If we wait just two years, the cost of bringing that same stretch of road up to par rises to $30 million. There are thousands of similar projects crying out to be done.

In a moment of crisis — or crises — analysts like to resort to light relief. This Friday, they were particularly inspired. Faced with another round of collapsed U.S. debt talks and a potential ratings downgrade for Spain, few shied away from using color and hyperbole.

A Commerzbank note was divided into sections: ”SOS!” and “Save our souls!”

Gary Jenkins at Evolution Securities toyed with fiction when trying to understand the current economic backdrop: “I am no longer sure if this is reality or I am watching a Hollywood summer blockbuster.”

The second Greek bailout was aimed at ring-fencing euro zone contagion, but could unleash it instead.

Comments from rating agencies since euro zone leaders agreed to involve the private sector in a  Greek rescue plan suggest last week’s events have increased rather than decreased the risk of contagion in the medium-term, says Gary Jenkins of Evolution Securities.

Fitch ratings stated on Friday:

If the Irish and Portuguese economies and public finances are not firmly on a sustainable path going into 2013, when both will need to regain access to medium-term market funding, the potential precedent set by PSI (private-sector involvement) in the Greek package will be incorporated into Fitch’s assessment of the risks to bondholders and reflected in its sovereign rating opinions and actions.

Even if politicians have so far been unable to come to an agreement that will allow the U.S. debt ceiling to be raised by Aug. 2, the popularity of U.S. Treasury auctions this week indicates investors are still keeping the faith. Still, some are starting to get pickier about which Treasuries they would like to hold.

All three government bond auctions this week enjoyed a strong reception. Yet buyers of the 30-year bonds sold on Thursday, for example, might have felt particularly sanguine about the August debt ceiling date because the first coupon payment on those bonds is not due until Nov. 15.

That contrasts with some older Treasury securities that have payments due Aug. 15 or Aug. 31 which have not traded due to “concern that the coupon payment could be missed,” said Justin Lederer, interest-rate strategist at Cantor Fitzgerald.

Worrying about the power China has over the U.S. as America’s largest foreign creditor has become a national pastime. It’s a bipartisan issue in Congress and a favorite subject among pundits lamenting the decline in U.S. influence around the world. But could China really use its Treasury purchases to shape U.S. policy? Diplomatic cables released by WikiLeaks and obtained by Reuters suggest that has already happened.

Emily Flitter’s special report outlines a diplomatic flare-up between the two superpowers following the U.S. financial crisis. Chinese officials said they were worried about the safety of their U.S. investments. U.S. diplomats worked hard to ease the tensions, but the conflict ultimately led to the request of a personal favor by a top Chinese money manager in a meeting with U.S. Treasury Secretary Timothy Geithner.

To read the special report in multimedia PDF format click here.

Paul Eckert has another special report out today based on WikiLeaks cables obtained by Reuters. This one sheds light on how the United States views China's likely next leader, Xi Jinping. See that PDF here.

The programme may strike a different  note -- this year's Davos is apparently all about Shared Norms for the New Reality -- but much of the discussion at the 41st World Economic Forum annual meeting in Davos this month will have a distinctly familiar ring to it.

Last January, the five-day talkfest in the Swiss Alps was dominated by Greece's near-death experience at the hands of the bond market and recriminations over the role of bankers in the financial crisis, as well as worries about China's rapid economic ascent and a lot of calls for a new trade deal.

Fast forward 12 months and not much has changed.

Ireland has joined Greece in the euro zone's intensive care unit and Portugal and  Spain are getting round-the-clock monitoring. The annual round of bankers' bonuses is once again stirring up trouble. China looms larger than ever on the global stage, after overtaking Japan in 2010 to become the world's second-biggest economy. And trade ministers who signally failed to make headway last year say they really must get down to business when they meet on the sidelines of Davos this time round.

Jim O'Neill, the new Goldman Sachs Asset Management chairman who is famous for coining the term BRICs for the world's new emerging economic giants, reckons he knows why Germany might not be rushing to bail out all the euro zone debt that is under pressure. Europe is not as important to Berlin as it was.

Speaking at the Reuters 2011 Investment Outlook Summit being held in London and New York, O'Neill pointed out that in the not very distant future Germany will have more trade with China than it does with France.

"It's a different global environment. That's why maybe Germany (ties)  itself to a rules-based game with the rest of Europe because economically it doesn't mean so much to them now. What goes on in China is more important than what goes on in France and that's puts a different economic (spin) on the situation for the Germans."

We went behind the scenes of Dubai's debt debacle last November and found a much more sober city-state starting to rebuild itself from the $59 billion hole that was dug by the whizz kids who had powered its transformation. Loans don't come as easy -- particularly the nod and the wink of association with the royal family isn't cutting it like it used to.

Some people see a connection between the crisis and the fact that Dubai has also started to tighten up on its trade with Iran, in line with broader international sanctions, but we're not so sure about that.

What did come across loud and clear in our reporting is that the new-new Dubai is currently being led more by older, senior types who had been thrown off the ladder by the MBAs and the like on their way up. Some of the financial types we spoke to worried about this: we don't need civil engineers, one said, we need financial engineers. It'll be interesting to see how it plays out.