The Coming Sovereign Debt Crisis
Deterioration of sovereign debt in Southern Europe has recently become
the key concern of financial markets.
Dr. Doom Nouriel Roubini predicted that this will become a concern in 2010.
He explains the problem in this Forbes article:
The Coming Sovereign Debt Crisis
Nouriel Roubini and Arpitha Bykere
In 2009, downgrades and debt auction failures in countries like the UK, Greece, Ireland and Spain were a stark reminder that
unless advanced economies begin to put their fiscal houses in order, investors and rating agencies will likely turn from friends to
foes. The severe recession, combined with a financial crisis during 2008-09, worsened the fiscal positions of developed
countries due to stimulus spending, lower tax revenues and support to the financial sector. The impact was greater in countries
that had a history of structural fiscal problems, maintained loose fiscal policies and ignored fiscal reforms during the boom
years. Going forward, a weak economic recovery and an aging population is likely to increase the debt burden of many
advanced economies, including the U.S., Britain, Japan and several eurozone countries.In 2008 and 2009, the decisions by these governments to do “whatever it takes” to backstop their financial systems and keep
their economies afloat soothed investor concerns. But if countries remain biased toward continuing with loose fiscal and
monetary policies to support growth, rather than focusing on fiscal consolidation, investors will become increasingly concerned
about fiscal sustainability and gradually move out of debt markets they have long considered “safe havens.”Most central banks will withdraw liquidity starting in 2010, but government financing needs will remain high thereafter.
Monetization and increased debt issuances by governments in the developed world will raise inflation expectations. These
governments will have to offer higher real yields or investors will move to more attractive emerging markets. Some countries will
continue to witness increased credit default swaps. Higher yields and interest cost on debt will also hurt economic growth—by
crowding out private consumption and investment, and reducing government’s productive spending. Several factors will likely
influence investors’ perception about sovereign risk—a country’s debt financing ability, its status as a “safe haven” relative to
other developed economies, politicians’ commitment to undertake fiscal reforms, exchange rate movements, and the debt
maturity structure.The UK, Spain, Greece and Ireland will face sovereign risk pressures, especially if their fiscal imbalances are not addressed
immediately. Some eurozone members are quickly approaching their debt sustainability limits as deleveraging through
devaluation is not an option for these countries. Countries like Germany—whose fiscal imbalances have deteriorated largely due
to the economic and financial downturn—might have a greater capacity to stabilize their debt ratio. The U.S. and Japan might
be among the last to face investor aversion—the dollar is the global reserve currency and the U.S. has the deepest and most
liquid debt markets, while Japan is a net creditor and largely finances its debt domestically. But investors will turn increasingly
cautious even about these countries if the necessary fiscal reforms are delayed. The U.S. is a net debtor with an aging
population, weaker economic growth and risks of continued monetization of the fiscal deficit. Japan’s aging population and
economic stagnation will reduce domestic savings.Developed economies will therefore need to begin fiscal consolidation as soon as 2011-12 by generating primary surpluses,
which can be accomplished through a combination of gradual tax hikes and spending cuts. However, an aging population, a
sluggish economic recovery and higher unemployment will keep governments’ entitlement spending high and revenues subdued.
These factors might also make tax hikes politically challenging. Fiscal consolidation efforts might not be strong until the bond
vigilantes signal shifting to safer assets. To achieve credibility, governments will need to pass binding legislation enforcing
tighter fiscal belts when their economies begin to recover on a sustained basis.Nouriel Roubini, a professor at the Stern Business School at New York University and chairman of Roubini Global Economics
(RGE), is a weekly columnist for Forbes. (Read all of his columns here.) Arpitha Bykere is a Senior Research Analyst at RGE.
Global stock market and sovereign default.
Sovereign defaults present serious risk for the stock market. Overall, stocks in
affected countries decline considerably, and the desease infects the rest of the
Globe. Here is a recent example, the currency crash in Iceland. While US is
much bigger, the problems in the US, the UK, and Southern Europe are all similar.
2008 proved that TBTF (too big to fail) do fail!
Be careful and prepared
China is undermining the dollar by the back-door
Over the past year since March 2009, the Federal Reserve not so quietly
engaged in a major printing effort (of 1.75 Trillion dollars), while
concealing the fact that this monetization was required to keep
US economy afloat.
They use the term of “quantitative easing” to mask the truth for the general
public. Quantitative easing is printing money out of thin air. They also
directed the printing presses toward bailing out very sick US mortgage
market (mostly MBS), although there was also explicit monetization of
treasuries.
Explicit monetization of US treasuries by the Fed is almost equivalent to
default. However, US credit rating agencies continue to rate US sovereign
debt as AAA (surprise!)
It appears China, the largest holder of US sovereign debt, is finally
starting to “get it”. If China is serious about De-pegging from US
dollar, as pressured by US authorities, then we may see US
dollar plunge. For now Chinese currency is pegged to US dollar,
thus, Chinese buying is determined by the peg. Read more in this article in FT.
China is undermining the dollar by the back-door
By Gerard Lyons
Published: April 27 2010 15:50 | Last updated: April 27 2010 15:50
There is a ticking time bomb under the dollar. When it explodes depends not just on the US economy
but also on policy actions in Beijing and Washington. Over the last year the Chinese have undermined
the dollar by the back-door, questioning it as a store of value and medium-of-exchange.Although the Chinese are not advocating the renminbi as the alternative to the dollar this may be only
a matter of time. One needs to focus on what the Chinese do, as well as listen to what they say. A key
development is China’s encouragement of international use of the renminbi, although they prefer to call it invoicing.This may be from a low starting point but one Chinese saying may be worth bearing in mind: “A march
of 10,000 miles begins with one small step”. Early signs are promising.China is encouraging exporters to invoice in the renminbi and is setting up systems to allow trade
payments in renminbi. This make sense. China’s trade is soaring. New trade corridors may soon
require new means of payment. When the Chinese and Brazilian Presidents met last
year they agreed to use their own currencies to settle more of their bilateral trade, rather than
invoicing in dollars. Although viewed as symbolic, it is a sign of things to come.……………..
The horrible state of US national debt
US national debt
This picture is from the Chicago tribune
US national debt is a disaster in the making. Currently the demand for treasuries
is being artificially propped by US credit rating agencies that downgrade European
countries but keep their mouth shut about the fiscal position of the United States and
the States in the United States, such as California, which are much worse off than
Greece (in the EU).
Sovereign risk and derivative domino effect.
While this web site was originally devoted to unhealthy imbalances
in the United States, these are currently present all over the globe.
As we have seen lately, as sovereign debt issues surfaced in Greece,
CDS market rapidly started pricing sovereign risk higher in other PIIGS
(Portugal, Italy, Ireland, Greece, Spain), the UK, Germany, and the US.
These imbalances in an isolated country normally occur after a financial
crisis, when the government attempts a Keynesian approach to fight
the crisis. If the fight is unsuccessful, the government assumes too
much debt, while the economy does not recover, a currency crisis
will follow (Argentina 2002, East Asia 1997, Russia 1998, Iceland 2008,
etc.,etc.).
The financial crisis of 2008 was global in nature, and the Economist
has a wonderful discussion of what might follow if the global economy
does not recover due to too much debt. I believe this is coming -
perhaps, later in 2010 or in 2011, as a consequence of the global
financial crisis of 2008.
Sovereign-debt worries – the Economist.
Domino theory
Assessing the risk that Greece’s woes herald something far worse
HOW far is it from Athens to America and which
countries lie on the way? That may sound like an esoteric geography
question, but it is being asked by investors as Greece’s debt crisis
creates global jitters about the safety of sovereign debt. So far
Portugal, Ireland and Spain, the other high-deficit countries on the
periphery of the euro zone, are thought to be next in line. In most big
rich economies, yields have been stable and well below their long-term
average (see chart).But nerves are fraying elsewhere. The cost of insuring against
sovereign default (see article) has risen in 47 of the 50 countries for
which these instruments exist. Dubai’s sovereign credit-default-swap
spreads soared to their highest level in a year this week, amid concern
about the terms of a debt restructuring by a state-owned
conglomerate. There is increasingly shrill commentary arguing that
Greece is the start of a far bigger problem. “A Greek crisis is coming to
America”, blared the headline on a recent Financial Times article by
Niall Ferguson, a financial historian.The stakes are high. A sudden loss of confidence in all sovereign debt,
and especially in American Treasuries, the world’s benchmark “risk-free”
asset, would have calamitous consequences in a still-fragile recovery.
Equally, an exaggerated fear of sovereign risk could prompt
governments into premature fiscal austerity, which might itself push
the world economy back into recession…..
A Shift in Sovereign Sentiment
In his excellent recent piece, Todd Harrison describes the sovereign debt problems
the globe now faces as a result of the financial crisis and compares the situation in
Greece with that at Bear Stearns in early 2008. US is far from being immune to the
problems in Europe. In fact, many states are much larger than European countries and
are in the same boat. Or, actually, they are much worse off.
A Shift in Sovereign Sentiment
By Todd Harrison
A message to CFTC – gaming the system will work no more.
CFTC recently engaged in a massive regulatory overhaul of the
commodity markets, targeting limited positions and increasing margins in commodities, in particular, in energy.
This affects exchange traded funds such as UNG (Natural Gas) and USO (oil). In their view, commodity speculators drove
oil and gas to unreasonable levels in the Summer of 2008, in part, triggering the current crisis.
While limited trading in any derivatives is a welcome step, this is, of course, ridiculous.
The run in commodities was triggered by the Fed drastically lowering interest rates and printing money to
save the literally huge derivative Ponzi scheme that our global financial system has become.
“Gaming” free markets is not the way to go. We did that for quite some time now, and that’s why
the financial crisis happened. The Free market broke free from all this derivative model manipulation
and this resulted in a Black Swan. As long as OTC derivative bubble is inflating further,
chances of another, deeper systemic crisis are increasing. If the current
policy of bailing out too big to fail counterparties continues, there is a chance the derivative
Ponzi scheme will eventually blow up and take down entire countries – including, possibly, USA.
Regulate what matters – OTC interest rate derivatives and credit derivatives!
John Embry of Sprott Asset Management on Fed’s options.
Essentially, the two choices for the Fed are not pretty -
hyperinflate or face a devastating deflationary collapse due
to mega-Ponzi derivative fiasco. The Fed chose hyperinflation.
“Any serious attempt to withdraw the stimulus at
this point will trigger a deflationary depression and
a continuation of the current policies will put us
firmly on the road to hyperinflation”
Inflation, Deflation, or a pure mess.
Do we have to worry about gold?
In my view, just buy physical gold and silver, GDX and GDXJ, and keep them. Gold
will go up. How much depends on policy actions. In particular, whether or not the
US government chooses to pursue very accomodative fiscal and monetary policy.
On the charts front, reconstructed M3 from Bart at nowandfutures.com and John
Williams at shadowstats.com shows a decline. However, inflation is picking up,
and the Fed printing so far is going ballistic.
The Fed emits tightening noises, but, given US employment situation, rates will
stay at Zero for a long time. The printing program will end in March, while the
government mortgage subsidy program ends in April. Then we will see how the economy
performs without direct money printing support, or what the Fed will do if it falters
again. This could be expected, since an enormous credit bubble popped in 2006-2008.
The danger of printing too much money…
The 1993-1994 hyperinflation episode in Yugoslavia has been the worst in modern history.
Between October 1, 1993 and January 24, 1995 prices increased by 5 quadrillion percent. That’s a 5 with 15 zeroes after it.
The Worst Episode of Hyperinflation in History: Yugoslavia 1993-94
Thayer Watkins, Ph.D.
1993 Yugoslav dinar banknote
Under Tito, Yugoslavia ran a budget deficit that was financed by printing money. This led to a rate of inflation of 15 to 25
percent per year. After Tito, the Communist Party pursued progressively more irrational economic policies. These policies and
the breakup of Yugoslavia (Yugoslavia now consists of only Serbia and Montenegro) led to heavier reliance upon printing or
otherwise creating money to finance the operation of the government and the socialist economy. This created the
hyperinflation.
By the early 1990s the government used up all of its own hard currency reserves and proceded to loot the hard currency
savings of private citizens. It did this by imposing more and more difficult restrictions on private citizens’ access to their hard
currency savings in government banks.
The government operated a network of stores at which goods were supposed to be available at artificially low prices. In
practice these store seldom had anything to sell and goods were only available at free markets where the prices were far
above the official prices that goods were supposed to sell at in government stores. All of the government gasoline stations
eventually were closed and gasoline was available only from roadside dealers whose operation consisted of a car parked with a
plastic can of gasoline sitting on the hood. The market price was the equivalent of $8 per gallon. Most car owners gave up
driving and relied upon public transportation. But the Belgrade transit authority (GSP) did not have the funds necessary for
keeping its fleet of 1200 buses operating. Instead it ran fewer than 500 buses. These buses were overcrowded and the ticket
collectors could not get aboard to collect fares. Thus GSP could not collect fares even though it was desperately short of
funds.
Delivery trucks, ambulances, fire trucks and garbage trucks were also short of fuel. The government announced that gasoline
would not be sold to farmers for fall harvests and planting.
Despite the government’s desperate printing of money it still did not have the funds to keep the infrastructure in operation.
Pot holes developed in the streets, elevators stopped functioning, and construction projects were closed down. The
unemployment rate exceeded 30 percent.
The government tried to counter the inflation by imposing price controls. But when inflation continued, the government price
controls made the price producers were getting so ridiculous low that they simply stopped producing. In October of 1993 the
bakers stopped making bread and Belgrade was without bread for a week. The slaughter houses refused to sell meat to the
state stores and this meant meat became unvailable for many sectors of the population. Other stores closed down for
inventory rather than sell their goods at the government mandated prices. When farmers refused to sell to the government at
the artificially low prices the government dictated, government irrationally used hard currency to buy food from foreign sources
rather than remove the price controls. The Ministry of Agriculture also risked creating a famine by selling farmers only 30
percent of the fuel they needed for planting and harvesting.
Later the government tried to curb inflation by requiring stores to file paperwork every time they raised a price. This meant
that many store employees had to devote their time to filling out these government forms. Instead of curbing inflation this
policy actually increased inflation because the stores tended to increase prices by larger increments so they would not have
file forms for another price increase so soon.
In October of 1993 they created a new currency unit. One new dinar was worth one million of the “old” dinars. In effect, the
government simply removed six zeroes from the paper money. This, of course, did not stop the inflation.
In November of 1993 the government postponed turning on the heat in the state apartment buildings in which most of the
population lived. The residents reacted to this by using electrical space heaters which were inefficient and overloaded the
electrical system. The government power company then had to order blackouts to conserve electricity.
In a large psychiatric hospital 87 patients died in November of 1994. The hospital had no heat, there was no food or medicine
and the patients were wandering around naked.
Between October 1, 1993 and January 24, 1995 prices increased by 5 quadrillion percent. This number is a 5 with 15 zeroes
after it. The social structure began to collapse. Thieves robbed hospitals and clinics of scarce pharmaceuticals and then sold
them in front of the same places they robbed. The railway workers went on strike and closed down Yugoslavia’s rail system.
The government set the level of pensions. The pensions were to be paid at the post office but the government did not give
the post offices enough funds to pay these pensions. The pensioners lined up in long lines outside the post office. When the
post office ran out of state funds to pay the pensions the employees would pay the next pensioner in line whatever money
they received when someone came in to mail a letter or package. With inflation being what it was, the value of the pension
would decrease drastically if the pensioners went home and came back the next day. So they waited in line knowing that the
value of their pension payment was decreasing with each minute they had to wait.
Many Yugoslavian businesses refused to take the Yugoslavian currency, and the German Deutsche Mark effectively became the
currency of Yugoslavia. But government organizations, government employees and pensioners still got paid in Yugoslavian
dinars so there was still an active exchange in dinars. On November 12, 1993 the exchange rate was 1 DM = 1 million new
dinars. Thirteen days later the exchange rate was 1 DM = 6.5 million new dinars and by the end of November it was 1 DM = 37
million new dinars.
At the beginning of December the bus workers went on strike because their pay for two weeks was equivalent to only 4 DM
when it cost a family of four 230 DM per month to live. By December 11th the exchange rate was 1 DM = 800 million and on
December 15th it was 1 DM = 3.7 billion new dinars. The average daily rate of inflation was nearly 100 percent. When farmers
selling in the free markets refused to sell food for Yugoslavian dinars the government closed down the free markets. On
December 29 the exchange rate was 1 DM = 950 billion new dinars.
About this time there occurred a tragic incident. As usual, pensioners were waiting in line. Someone passed by the line
carrying bags of groceries from the free market. Two pensioners got so upset at their situation and the sight of someone else
with groceries that they had heart attacks and died right there.
At the end of December the exchange rate was 1 DM = 3 trillion dinars and on January 4, 1994 it was 1 DM = 6 trillion dinars.
On January 6th the government declared that the German Deutsche was an official currency of Yugoslavia. About this time the
government announced a NEW “new” Dinar which was equal to 1 billion of the old “new” dinars. This meant that the exchange
rate was 1 DM = 6,000 new new Dinars. By January 11 the exchange rate had reached a level of 1 DM = 80,000 new new
Dinars. On January 13th the rate was 1 DM = 700,000 new new Dinars and six days later it was 1 DM = 10 million new new
Dinars.
The telephone bills for the government operated phone system were collected by the postmen. People postponed paying these
bills as much as possible and inflation reduced their real value to next to nothing. One postman found that after trying to
collect on 780 phone bills he got nothing so the next day he stayed home and paid all of the phone bills himself for the
equivalent of a few American pennies.
Here is another illustration of the irrationality of the government’s policies: James Lyon, a journalist, made twenty hours of
international telephone calls from Belgrade in December of 1993. The bill for these calls was 1000 new new dinars and it arrived
on January 11th. At the exchange rate for January 11th of 1 DM = 150,000 dinars it would have cost less than one German
pfennig to pay the bill. But the bill was not due until January 17th and by that time the exchange rate reached 1 DM = 30
million dinars. Yet the free market value of those twenty hours of international telephone calls was about $5,000. So despite
being strapped for hard currency, the government gave James Lyon $5,000 worth of phone calls essentially for nothing.
It was against the law to refuse to accept personal checks. Some people wrote personal checks knowing that in the few days
it took for the checks to clear, inflation would wipe out as much as 90 percent of the cost of covering those checks.
On January 24, 1994 the government introduced the “super” Dinar equal to 10 million of the new new Dinars. The Yugoslav
government’s official position was that the hyperinflation occurred “because of the unjustly implemented sanctions against the
Serbian people and state.”