05/10/10 Laguna Beach, California – The leaders of the European Union huddled together over the weekend to devise a dramatic rescue plan for the euro. When they broke from their huddle they announced a $645 billion war chest (of borrowed money) with which to defend their 11-year old currency.
The massive rescue plans seems nearly certain to work…for a day or two…and maybe even for an entire week. But trying to combat debt fears with a great big pile of additional debt hardly seems like a winning formula. Rescue plans rarely rescue much of anything.
At the heart of issue lies the simple fact that most European governments are heavily indebted and are increasing their indebtedness at a catastrophic pace. After decades of dispensing services and benefits that tax revenues failed to cover, the moment of truth has finally arrived. And it is too late for austerity measures or tax hikes to restore solvency. Therefore, without some combination of bailouts and money-printing, several governments might default.
As this seemingly unthinkable possibility becomes “thinkable,” if not likely, every heavily indebted sovereign borrower in the world is starting to wonder if they might be next. This situation is very serious, very pervasive and very unlikely to be cured by any sort of “rescue plan.”
The panic of early 2009 may be gone and the “crisis mentality” resulting from the Lehman Bros. bankruptcy has vanished. But the seeds of the next crisis are germinating already. Excessive debt remains a very serious problem in almost every corner of the global economy. Here in the US, consumers remain very highly leveraged and US banks continue to hold enterprise-threatening levels of impaired loans. Meanwhile, sovereign borrowers from Greece to Portugal…to America are struggling with unsustainably large liabilities.
For the moment, the Greek debt crisis has sparked substantial “flight to quality” buying of US Treasury securities. But panic selling has become the norm in almost every other sovereign debt market.
But “quality” may be in need of a re-definition.
The Congressional Budget Office’s latest numbers reveal that America’s national indebtedness will increase by $9.7 trillion over the next 10 years. Further, the CBO projects the national debt will be 90% of GDP by the end of this decade. This projection seems very optimistic, as America’s national debt has already reached 86% of GDP.
Unfortunately, America’s finances are not unique; they are emblematic. Sovereign borrowers throughout Europe are suffering from a toxic combination of sky-high debt and overly generous entitlement programs.
The charts above and below place the Greek crisis in a global context. The chart above shows the total “bare bones” funding requirement for various countries during the next three years. Specifically, this chart shows the amount of borrowing that would be required by each country to fund anticipated deficits during the next three years and to re-finance all government debt coming due in the next three years. The resulting sum is expressed as a percentage of annual GDP.
As expected, countries like Italy and Greece are high on the list. But surprisingly, the US is on par with Spain and Portugal. The chart below presents the exact same data in absolute terms, rather than as a percentage of GDP. America’s three-year funding requirement seems much more ominous when viewed in absolute dollars. These charts clearly show that no indebted country is immune from the kind of investor scrutiny that could produce a debt crisis…or a currency crisis.
Most central bankers of the world realize this fact. That’s why they all wish to support Greece – not because they care about Greece, but because they care about avoiding close scrutiny of their own finances.
Runaway government borrowing creates a frightening context for any would-be buyer of government bonds. That’s why long-dated bonds may be some of the riskiest assets on the planet at the moment. (And why rising interest rates may become one of the most important investment influences over the next several years.)
Although near-term economic weakness, and/or “flight to quality” buying, may exert some downward pressure on US Treasury yields over the short term, runaway government deficits will exert upward pressure on Treasury yields over the long term.
Volatility is the new “black.”
Eric Fry
for The Daily Reckoning
Eric Fry
Eric J. Fry, Agora Financial’s Editorial Director, has been a specialist in international equities for nearly two decades. He was a professional portfolio manager for more than 10 years, specializing in international investment strategies and short-selling. Following his successes in professional money management, Mr. Fry joined the Wall Street-based publishing operations of James Grant, editor of the prestigious Grant's Interest Rate Observer. Working alongside Grant, Mr. Fry produced Grant's International and Apogee Research — institutional research products dedicated to international investment opportunities and short selling.
Mr. Fry subsequently joined Agora Inc., as Editorial Director. In this role, Mr. Fry supervises the editorial and research processes of numerous investment letters and services. Mr. Fry also publishes investment insights and commentary under his own byline as Editor of The Daily Reckoning. Mr. Fry authored the first comprehensive guide to investing internationally with American Depository Receipts. His views and investment insights have appeared in numerous publications including Time, Barron's, Wall Street Journal, International Herald Tribune, Business Week, USA Today, Los Angeles Times and Money.
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Excellent comments! Curing debt with more debt is just more of the upside Bernanke in Wonderland type thinking that caused and continues the awful mess of international finance. Your thoughts are prudent and should be on every chief executive’s desk.. if they’d be willing to face the bald truth.