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Why Greece Isn’t Like U.S. Revealed in Bonds: Cutting Research

Dec. 7 (Bloomberg) -- The vulnerability of economies to sovereign debt crisis may depend on who’s holding their bonds.

That’s a signal from a new index designed by International Monetary Fund economists. It seeks to show which advanced economies have the flightiest sources of investment and so are most at risk of sudden capital outflows.

The gauge, published in a working paper this month, runs from zero to 100. A higher score means that the country is more prone to a sudden buyers’ strike from investors. A country with a zero rating would have all its debt held by the domestic central bank, while a 100 reading means all the country’s debt would be owned by foreign investors such as insurance companies and hedge funds, excluding governments and banks.

Created by IMF economists Serkan Arslanalp and Takahiro Tsuda, the index is based on a dataset from 24 major advanced economies and $42 trillion of sovereign debt holdings from 2004 to 2011.

The measure suggested the euro-area economies that received bailouts exhibited high risk of outflows as early as 2010. Greece was rated at 75 in the fourth quarter of 2009, when it could still borrow in the market. With results of 39 and 44 respectively at the end of 2011, Spain and Italy are less threatened because of the high share of debt in the hands of domestic banks, the report said.

With scores of less than 25 at the end of 2011, Australia, Japan, Switzerland and the U.S. were among those identified as having safer sources of finance. Germany scored 40 a year ago.

The index can explain some classic “puzzles” of why certain countries can sustain much higher debts without market pressure, said Arslanalp and Tsuda.

For example, while Japan has a debt equivalent to more than 200 percent of gross domestic product, a lot of it is held domestically and so is less at risk of flight, they said, while the U.K., Germany and U.S. may be in a similar class.

The study also found a rising share of foreign investors in sovereign debt markets even after $400 billion of withdrawals from the euro region’s most strained nations from mid-2010 to the end of 2011.

Banks are also increasingly exposed to their own government’s debt. Sixty-nine percent of euro-area bank’s regional debt holdings were of their own sovereign issues at the end of 2011, up from 57 percent at the end of 2007. In Greece, Italy and Spain, the ratio was closer to 100 percent.

The results “show that large funding gaps may arise in a number of countries in case of severe foreign outflows, requiring large absorption by domestic banks,” said Arslanalp and Tsuda.

* * *

Two thousand years of history show recent trade imbalances in the world economy are nothing unusual.

Between 1 AD and 3 AD, Rome ran persistent trade deficits with India, Deutsche Bank AG strategist Sanjeev Sanyal wrote in a Nov. 30 study. He noted that the Roman philosopher Pliny once said “not a year passed in which India did not take fifty million sesterces away from Rome.”

By the 16th century, Spain was running trade deficits as it imported resources to sustain its empire and fight wars, paying for the gap with Andean silver. In the late 19th century, the U.K. acted as the world’s economic engine with a steadily growing trade gap.

The rare period in which there was balance came in the first half of the 19th century. It was an era of three-way trade in which Britain sold manufactured goods to India in return for opium. That in turn was sold to China for tea and porcelain.

“History shows that the global economy is not characterized by balance, but by long periods of symbiotic imbalances,” said Singapore-based Sanyal.

* * *

Investors seeking to gauge whether a central bank will shift interest rates should look how it voted the previous time.

So says a paper published this month by the International Journal of Central Banking, focused on the track record of central banks in the Czech Republic, Hungary, Poland, Sweden and the U.K. The study found that if even a minority votes for higher rates at one meeting, it’s more likely that there will be a rate increase at the subsequent gathering.

“In all these countries the voting records are indeed informative about future monetary policy and thus in principle improve monetary policy predictability,” said economists Roman Horvath of Charles University in Prague, the Czech National Bank’s Katerina Smidkova and Jan Zapal of the London School of Economics.

Interestingly for the European Central Bank, which doesn’t publish its governing council’s votes in part because it doesn’t want its officials to face criticism at home, the report said the predictive results hold even if the votes of individual policy makers are concealed.

* * *

China needs to open up trading of financial assets before letting its exchange rate float if it is to protect its economy from foreign shocks.

That’s according to a Dec. 3 report by two economists from the Federal Reserve Bank of San Francisco who studied how China prohibits its private sector from freely trading overseas assets and manages its currency.

Against that backdrop, China has found it harder to set monetary policy in recent years. Interest rates on its foreign assets fell following the global financial crisis, while yields on its own domestic assets stayed high, Zheng Liu and Mark M. Spiegel wrote.

“Opening the capital account would improve China’s capacity to weather economic shocks, such as sudden declines in foreign interest rates,” they said. “However, allowing the exchange rate to float without removing capital controls is less effective,” they said.

* * *

Greater volatility in financial markets and lower price differentials provoke increases in high-frequency trading, according to a Bank of England working paper.

High-frequency trading occurs when companies use computer programs to trade at high speed and try to avoid holding positions overnight.

Such a practice is of interest to the U.K. central bank because there is little insight into it and because of recent mishaps such as May’s 2010 “Flash Crash,” economists Evangelos Benos and Satchit Sagade wrote in a study published this month.

The Bank of England “has a natural interest in better understanding HFT behavior and how it might impact the quality of U.K. equity markets,” the study said.

High-speed trading technologies can inject useful levels of volatility into markets and are less likely than other traders to generate excessive moves -- those not triggered by fundamentals, the report said.

“It is not immediately clear what the welfare implications of HFT activity are,” the report said. How they are embraced may ultimately depend on “how much additional noise we are willing to tolerate at some times for the benefit of more informed trading at other times.”

To contact the reporter on this story: Simon Kennedy in London at at

To contact the editors responsible for this story: Craig Stirling at

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