Risk-Free in Name Only

One of the sillier promises made during the recent presidential campaign was to review the federal budget line by line. What a Zen experience that would be. It recalls two similar efforts -- Jimmy Carter's zero-based budgeting and Ronald Reagan's war against "waste, fraud and abuse," as if those were line items in the budget.

Speaking of abuse, let's turn our attention to what governments around the world have been doing to their sovereign credit ratings since the mid-July backstopping of Fannie Mae (FNM - commentary - Cramer's Take) and Freddie Mac (FRE - commentary - Cramer's Take) by the U.S. government. This is in addition to a much longer history of governments trying to meet their spending desires and those of key constituencies by debauching their own currencies. The sad history in the U.S. includes the 1933 suspension of the dollar's convertibility into gold, the closure of the gold window in 1968 and the move to floating exchange rates with the 1971 Smithsonian Agreement.

Those pieces of green paper in your pocket are nothing more than Treasury debt, a weak link to reality given the almost unbelievable expansion of government credit obligations since July. And we are not alone in official abuse of credit; as we shall see below, the full faith and credit of Uncle Sam ranks high on the world scale. But the last time there was such an explosion of global liquidity -- the 1969-1970 episode corresponding to the creation of Special Drawing Rights at the International Monetary Fund -- we had a decade of runaway global inflation soon thereafter.

Sovereign Credit Risk

Change in National 5-Year CDS Costs After De Facto GSE Nationalization

Click here for larger image.

Source: Bloomberg

Let's return to a topic visited here in September, credit default swaps (CDS) on U.S. Treasuries and extend the analysis across a range of other governments' five-year notes. The chart below sorts these CDS costs in descending order of last Friday's values, marked in blue, in comparison to the values from Friday, July 11, 2008, marked in red. The CDS costs for the U.S. are expressed in euros, not in dollars, on the charming theory that if the U.S. government defaults, those euros you receive in recompense will be worth something.

The Y-axis is logarithmic, which means the vertical range represents percentage change. All sovereign CDS costs rose over the four-month period; not one government's credit risk fell. Some of the largest percentage increases were seen in low-risk countries such as Germany and Austria; other large percentage increases were seen in weak credits such as Russia, Iceland, Venezuela and Argentina. A few weak credits, such as Vietnam, Turkey and the Philippines, had small percentage increases.

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Howard L. Simons is president of Simons Research, a strategist for Bianco Research, a trading consultant and the author of The Dynamic Option Selection System. Under no circumstances does the information in this column represent a recommendation to buy or sell securities. While Simons cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.

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