Are Sovereign Borrowers the Next Crisis Catalyst?

Our little bull market is one year old today. Yep, that’s right, just one year ago our little cherub came into the world… And my how it has grown!

Since touching a 12-year low on March 9, 2009, the Dow has bounced more than 61%. Over the same timeframe, the S&P 500 has soared 72% and the NASDAQ has jumped 84%. These eye-popping numbers could lead one to believe that all is right with the world…or at least that all is much better than it was one year ago.

But your editors are skeptical of this assessment. It’s true that the widespread panic of early 2009 is gone and the crisis mentality has vanished. But here in early 2010, the seeds of the next crisis are germinating nicely.

Even without any new problems, the economy is still struggling with serious difficulties like sky-high unemployment and stubbornly high mortgage defaults. But new problems are already on their way. In the private sector, for example, commercial real estate defaults are rising exponentially. That’s bad. Over in the public sector, government indebtedness is rising exponentially. That’s really bad.

“The CBO’s latest numbers reveal that America’s national indebtedness will increase by $9.7 trillion over the next 10 years,” our colleagues at The 5-Minute Forecast report. “The White House projection is only slightly less staggering – $8.5 trillion. Further, the CBO projects the national debt will be 90% of GDP by the end of this decade – higher than the 83.4% recorded at the end of fiscal 2009 last fall.”

Unfortunately, America’s finances are not unique; they are emblematic. Sovereign borrowers are out of control.

“It amazes me how complacent the market remains about the situation in Europe,” says Dan Amoss, the mind behind the Strategic Short Report. “It’s become quite obvious that there are no easy, painless solutions to the crisis in Greece. Economic growth in Europe will disappoint, because governments and banks taxed and borrowed from the productive private sector about as much as they can.

“It’ll be very difficult for Europe to avoid painful reforms to its gold-plated welfare state programs,” Dan continues. “Government spending will fall. Tax rates will go up, but may, in fact, lead to lower tax revenues. Yet the market is acting as though this huge problem will just be swept under a rug.

“The youth throughout Europe are suffering from chronic levels of high unemployment,” says Dan. “This not only includes countries like Greece and Spain, but also includes Germany and France. The powerful influence of unions has limited the opportunities of new entrants into the labor force. And a high youth unemployment rate is not good for social stability. The disease that will afflict financial markets in the coming years is unaffordable debt at all levels of society. Greece is just one symptom. More will pop up in 2010.”

Ironically, as government finances around the world deteriorate, many corporate bonds will begin to provide a more compelling destination for investment capital than government bonds. In other words, the uglier that government finances become, the prettier corporate finances appear…

Eric Fry
for The Daily Reckoning