The magnitude of current
private and government debt, coupled with massive unfunded contingent
liabilities for promises of future services to their citizens, will prove to
be impossible for many nations to fund. Massive inflation in the money supply
will become the preferred vehicle to deflect the default monster and will
result in vastly devalued currencies and price inflation as a prelude to
default. Such action will be a desperate attempt to buy time to stave off the
inevitable and will result in social unrest caused by persons whose
comfortable lifestyle and elevated standard of living is about to
disintegrate before their very eyes.
What is 'Sovereign' Debt?
In its simplest form,
'sovereign' debt means 'government' debt, the financial debt of a country. It
usually also means the accumulated debts of government sub-entities such as
states, provinces, municipalities, agencies, boards and commissions for which
the senior government is ultimately responsible.
While existing government debt
is the problem for today, contingent liabilities for promises of future
services to its citizens dramatically complicates the current debt problem.
Unfunded future liabilities are obligations which represent the one ton
gorilla peering through the front window of many nations.
What does Debt 'Default' Mean?
Which Countries are Most Likely to Default?
According to the Maastricht
Treaty which sets the terms of compliance for the sixteen member nations of
the Euro currency club, annual deficits are limited to 3% of GDP. Of the 27
European Union member states, according to the IMF and the Global Financial
Stability Report of April 2010, only 5 countries (Luxembourg, Finland,
Denmark, Sweden and Bulgaria) are below that ceiling. Even worse, of the 22
that do not comply, 14 have a ratio that is more than twice the established
and agreed upon limit. Indeed, the EU-27 as a whole, posts a huge 6.9% budget
deficit-to-GDP ratio which is expected to increase in 2010 to 7.5% matching
Japan's at 7.5% but paling in comparison with the U.S.'s deficit-to-GDP of
9.2%! For the record, Canada's stands at 3.0% and Sweden's is only 0.8%!
Moreover, when we contemplate
the Maastricht Treaty's limit on gross external debt as a % of GDP,
set at 60%, we note that the majority of EU member states fail to comply. Indeed,
according to a recent study by the IMF, of the top 20 offenders when it comes
to gross external debt to GDP globally, 15 were European Union members with
the other 5 including the countries of Japan and the United States.
According to the Bank for International
Settlements the number-one offender globally in 2011 is projected to be Japan
at 204% gross debt as a % of GDP followed by Greece and Italy at 130%;
the U.S. at 100%; France at 99%; Portugal at 97%; the U.K. at 94%; Ireland at
93%; Germany at 85%; the Netherlands at 82% and Spain at 74%. Interestingly,
the U.S. level of 100% is actually greater than all but one of the much
ballyhooed countries of Portugal, Ireland, Greece and Spain (the PIGS). On
average the EU had a gross debt to GDP ratio of only 72.6% in 2009 (albeit up
from only 61.5% in 2008) but this is expected to reach 83.7% in 2011 (88.2%
in the euro area) as compared to 41% for Asia, only 35% for Latin America and
just 29% for central Europe.
Economists Reinhart and Rogoff
recently published comprehensive new research covering several hundred years
of economic history which determined that countries that reached debt levels
of 90% of their GDP, rapidly descended into the flames of default hell.
Specifically they found that when government debt-to-GDP rise above 90%, it
lowers the future potential GDP of that country by more than 1% and locks in
a slow-growth, high-unemployment economy. The authors point to history that
shows that public debt tends to soar after a financial crisis, rising by an
average of 86% in real terms. Defaults by sovereign entities often follow.
That being the case, it certainly raises a very red flag as to what we can
expect the future to hold for the U.S. and the U.K. let alone Japan, Italy,
Ireland and Portugal
Given that current interest
rates are at multigenerational lows, it seems entirely plausible that when
interest rates start rising, the burden of higher interest rates on the bonds
issued to secure additional borrowed funds, will become virtually unserviceable.
If interest rates were to double from their current 3% levels on 10 year
maturing bonds or double from the current 5% on 30 year bonds, most of these
nations would very quickly reach the brink of default.
What are the Common Characteristics of Debt Default Candidates?
Many countries are advanced
first world economies with high standards of living. Most share political
traditions and values whereby the welfare state ensures high living standards
and guarantees protection and security against most of life's challenges.
Such cradle to grave security requires ever higher levels of savings and
investments which result in wealth generation and serve as a growing tax base
sufficient to deliver on promises of current and future benefits, especially
with the universal demographic of rapidly aging populations.
Virtually all countries
subject to concerns about default, however, show shortfalls in economic
growth resulting in anaemic tax revenues requiring more credit and borrowing
in order to compensate. Now that credit is either tightening or isn't
available and interest rates are rising again, this game of spend and borrow
is about to end.
Can Debt Default be Avoided?
Remember the alarm we
experienced less than 2 years ago when the largest investment banks seemed to
be taking the entire world into a financial abyss? More importantly, remember
how it was 'resolved?' Over US $700 Billion was allocated immediately by the
U.S. Congress to the Treasury Secretary for whatever mitigation measures were
thought necessary. The Federal Reserve Board followed with many other
exceedingly inventive measures costing US $Trillions of borrowed taxpayer
dollars designed to lubricate creaky financial joints. That was government
bailing out private institutions in the financial sector, but what happens
when governments themselves require emergency financial assistance?
Greece represents only 2.5% of
the Euro club GDP economy, yet it took weeks to arrange US $140 Billion of
assistance. What happens when countries with much larger economies and needs
ask for assistance? The International Monetary Fund is making itself visible,
but after the recent levy on member nations, they have only managed to bring
their kitty from US $50 to $500 Billion. Spain, Italy or the UK could mop
that amount up in short order. Then what? Financially broken nations will be
funding other financially broken nations. Does that seem like a workable
plan? What happens when the banks which are creditors of these nations line
up for assistance again, as they did in late 2008? Who bails them out this
time when their own governments are broke?
A cynic might even suggest
that sovereign debt bailouts are not primarily designed to assist nations
nearing default, rather it allows them to pay their obligations to their
foreign bank creditors which hold the bonds of the nations nearing default.
In other words, collective efforts from the likes of the French, German,
British, Spanish governments and others recently, was merely an elaborate
ruse to keep their own banks solvent from the impending default of debtor
nations.
The staid and highly regarded
Bank of International Settlements based in Switzerland recently issued a
sobering report in which it stated the need for "drastic measures ... to
check the rapid growth of current and future liabilities and reduce the
adverse consequences of long term growth (of debt) and monetary
instability." It went on to note that there is currently over US $600
Trillion of global financial Derivatives Debt ... which is 10X annual global
GDP.
Can sovereign debt default be
avoided? Unfortunately, it doesn't look like that is in the cards.
Where Should You Invest in Times Such As These?
Precious metals are 'Real
Money' which will be your safe haven during the very financially troubled and
volatile period ahead and shield you from the rampant inflation and currency
devaluations that are on the horizon. As such, I believe that investments in
gold and silver in the form of bullion or mining company shares, complemented
by investments in other commodities such as select base metals, oil and gas
and agricultural grains, will give you peace of mind.