Investors were not worried about default risk on Spanish or Irish sovereign debt, or about Italy s chronically large sovereign debt.

The risk premia on the sovereign debt of Greece, Ireland, and others have not diminished.

It didn t work. Eurozone sovereign debt turned out not to be homogenous with respect to risk.

Of course, some believe that the Fed s mass purchases of US debt poses an even bigger risk than Europe s sovereign debt crisis.

Sovereign Environmental Risk

NEW YORK Today s swollen fiscal deficits and public debt are fueling concerns about sovereign risk in many advanced economies.

But the risk that the world s investors currently are trying to avoid by rushing into US, Japanese, and German sovereign debt is not a fundamental risk.

Sovereign Debt at Square One

In some countries with high levels of debt and impaired growth, fiscal stimulus could raise the risk premium on sovereign debt and be counterproductive others have more flexibility.

With more than 40 trillion of sovereign debt in global markets at any given time, that is a very high risk game.

As a result, sovereign risk is now becoming banking risk.

How to Default on Sovereign Debt

Sovereign debt no longer looks stable.

Sovereign debt restructurings with private creditors

Nevertheless, the crisis should abate somewhat, because the most risk averse institutions have by now sold their holdings of peripheral countries sovereign debt.

Investors subsequent efforts to price in the risk of a eurozone breakup not the volume of sovereign debt caused bond yields to spike.

If the EU wants a monetary union in which sovereign debt is relatively homogenous with respect to risk, fiscal discipline must be similarly homogenous.

A New Approach to Eurozone Sovereign Debt

The sovereign debt crisis is well known.

The Root of All Sovereign Debt Crises

The sovereign debt and banking crises have become even more closely interlinked as banks bought greater amounts of their home countries sovereign debt.

The ECB s treatment of all such debt as equally powerful sources of back up liquidity now trumps any analysis of differences in long term sovereign risk.

It is likely that growing natural resource scarcities are driving a paradigm shift, with potentially profound implications for economies and thus for sovereign debt risk worldwide.

But building institutions takes time, which is in dangerously short supply, given the risk of bank runs, sovereign debt crises, and the collapse of the single currency.

Sixth, rising government debt ratios will eventually lead to increases in real interest rates that may crowd out private spending and even lead to sovereign refinancing risk.

The eurozone, currently wrestling with fiscal imbalance and sovereign debt risk, has a strong and autonomous central bank, but is fiscally fragmented and only partly unified politically.

This means no cross border sovereign debt (or esoteric instruments, such as collateralized debt obligations).

China s Hidden Debt Risk

In the face of high systemic risk, private capital is leaving banks and the sovereign debt markets, causing governments borrowing costs to rise and bank capitalization to fall.

The country s sovereign debt should have been restructured without delay.

The link between sovereign debt and bank debt has to be broken once and for all.

Traditionally, sovereign risk has been concentrated in emerging market economies.

Sovereign debt was eventually restructured through the creation of Brady bonds.

Greek sovereign debt has been downgraded to below that of Egypt.

Table 3 Recent sovereign debt restructurings with private creditors main features

With the onset of the European sovereign debt crisis in 2010, banks appetite for public debt fell again.

And the evidence confirms that the euro crisis is not really about sovereign debt, but about foreign debt.

But the declining value of their sovereign debt and the size of that debt relative to that of Europe s smaller distressed countries implies much greater erosion of banks capital base, raising the additional risk of liquidity problems and further economic damage.

The European Central Bank s announcement of its outright market transactions program has reduced the risk of a sovereign debt crisis in the eurozone periphery and a breakup of the monetary union.

Currently, they are wrestling with widening sovereign debt problems and high unemployment.

Interest rate spreads on Italian sovereign debt have widened, but not sharply.

In Europe, risks spreads are rising on Italian and Spanish sovereign debt.

So governments bailed out banks and economies, producing a sovereign debt crisis.

Clearly, environmental risks are potentially large enough to affect countries economies in ways that could influence their willingness or ability to repay sovereign debt. In addition, these risks vary widely across countries, including countries whose current credit ratings suggest similar levels of sovereign risk.

Sharp rises in sovereign, corporate, and interbank liquidity spreads will increase the cost of capital, and increases in risk aversion, volatility, and sovereign risk will undermine business, investor, and consumer confidence further.