Forget about Politicians and Eurobonds - it's all about Trade! For many years developed market investors have not had to consider sovereign defaults when investing, other than perhaps any sales exposure that the companies they invested in had to possible defaults in Emerging markets. Alas, with Greece likely to default and increasing numbers of European nations being shunned by the markets this is no longer the case. This newsletter is meant to help investors understand how debt crises emerge, and how they are solved.

Typically debt crises occur when a country consumes more than it produces, and it requires foreigners to lend to them to finance this consumption. If foreigners begin to lose confidence in a country's ability to repay its debt, they will often sell the debt and the currency. If the country has issued debt in a foreign currency, this can cause the debt problem to escalate, as the debt will increase in size as the currency devalues. If investors sell the debt, the interest rate at which the government has to borrow increases, making debt levels unsustainable. Hence, often debt crises descend into vicious cycles, from which it is very difficult for countries to escape. But in many cases, markets' concern on debt has proven unfounded, and this created very attractive opportunities for investors. At lows, sovereign debt offer equity like returns with only sovereign debt risk.
In my opinion, the time to buy distressed sovereign debt is when its current account moves from deficit to surplus. This shows that the nation can now fund its consumption through its own exports, rather than running down savings or increasing debt. To make an analogy, lenders much rather make a loan to a household that is able to save at least some of its income, than to a household that persistently spends more than it earns. For nations, this point occurs when the current account moves positive.

David Fuller's view This makes sense to me. I would rather buy distressed sovereign debt when a country's current account moves from deficit to surplus, than some so-called 'safe haven' long-dated debt of countries locked in current account deficits.