Explaining Ireland\’s bonds

Investors have watched Ireland very closely for months, but concerns were heightened this week after French and German officials said bondholders should share any losses linked to a potential sovereign debt restructuring. Until now investors and governments operated on the basis that the EU would guarantee the interest payments of any EU country.

That\’s the current situation in a nutshell.

The EU has been implicitly insisting that there will be no defaults on eurozone sovereign bonds. Now the muttering is that there will be: perhaps not outright default, but restructurings and haircuts all around.

This isn\’t, actually, anything at all to do with austerity, a collapsing economy, tax revenues heading south or any of the other things that certain lefties are using Ireland to try and prove to us. You know, the Keynesian way out of a double dip recession and all that.

This is, quite simply, the markets (no, not bond vigilantes wanting to punish people or anything) being forward looking.

Last week the assumption was that capital values were safe: the bonds would be repaid at par. Somehow: the EU would step in, something.

The assumption this week is that the EU won\’t step in without there being a sharing of the pain: bonds won\’t be paid back at par. There will therefore be a capital loss to those holding Irish bonds (do note this is also nothing to do with the prices being charged for new Irish bonds: there aren\’t any on offer anyway).

So what\’s a rational holder of Irish bonds to do? Yup, let\’s go sell them before they cut the value of the bonds through restructuring and/or partial default.

This is in fact proof perfect of something which we are all told we should abdure. The efficient markets hypothesis (EMH). Far from current events proving it wrong, current events are proving it correct.

Recall, all it really says is that when trying to price something in a market then markets are efficient processors of the information regarding how those prices should be determined. Damn close to a tautology.

An implication of this is that prices should change when new information is available for the market to process. New information has arrived, prices have changed.

This refutes the EMH in what manner?

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