Financial Problems - Thy Name is Debt!

Is our “Crash Alert” flag still flying?

It is?

Good. Just checking.

Don’t breathe too hard. Don’t touch anything. We’re on tiptoes… So many things could bring this stock market crashing down. We can go around the world and point at them. China. Ireland. America itself…

And, oh yes, North Korea is firing rockets at South Korea….

Yesterday, the Dow lost 142 points. Gold rose $19.

Over time, the tensions, contradictions and pressures build up. You try to fix one thing with a little central planning…but the thing doesn’t cooperate. So you try to fix something else. And then another thing goes phlooey and you have to fix that.

One day you’re trying to keep Ireland afloat in the North Atlantic. The next day you’re worrying about an explosion in the Middle Kingdom. And then, wouldn’t you know it, a problem flares up right at home.

Financial problems – thy name is debt!

What’s the matter in China? Too much debt in the LGFVs – Local Government Funding Vehicles. A municipality thinks it will be a better place if it had a new mall. So it makes a deal. It helps borrow the money. It helps with the plans. The pols feel like big shots. Money changes hands…some of it legit, a lot of it under the table.

What’s not to like?

Well, do that a few thousand times all over China and pretty soon you have a lot of debt based on projects that never really made any sense in the first place. And where is the debt? In the banks, probably. Who knows what’s in the banks? But they’re the same banks that are funding the most reckless, breakneck speed capital investment program of all time.

Americans consume. The Chinese build. They’re building roads, bridges, towns, railroads, rail links, railheads – everything you can think of. Of course, some of this is necessary. Some of it is productive. But how much? How many local governments are making wise, productive investment decisions?

The Chinese are now spending almost half of their GDP on fixed investments – you know, the kind of stuff that has concrete and steel in it. One out of every two dollars goes to building something more or less permanent.

But how many of those decisions are going to pay off? How much of that investment is going to pay for itself? How much of the debt is going bad?

Darned if we know. No one knows. But Dear Readers are advised to be somewhere else when all this blows up.

It will. We’re sure of it. You can’t make that many capital investment decisions without making a lot of bad ones. You can’t grow that fast without some pretty severe growing pains.

And that’s just China. What about the Emerald Isle? Their problem is debt too. But it’s not LGFV. It’s MBL – mortgage backed lending. Europe’s big banks lent to Irish banks so the Irish banks could lend to Irish homeowners. Trouble is, the Irish homes are now not worth what the Irish homeowners paid for them. So, the micks and paddies have a lot of debt that is never going to be repaid.

Who will take the losses? Normally, it’s a simple question with a simple answer: the people who made the bad investments. But not now.

The news yesterday was that it would take $114 billion to keep Ireland open for business. And Spanish bond yields were hitting new records – investors are afraid they might be the next to go.

European authorities – including the Irish themselves – are afraid that if they let the chips fall where they may…many of them will fall on their own heads. They’re afraid of “contagion” – that is, they’re afraid that if the Irish get sick, they might get sick too. If Irish debt is allowed to collapse, in other words, so will their own bad debt. And who knows where that will lead?

We don’t. But we want to find out. Because we don’t see any better way to get rid of it than just letting it collapse. And so what? A few banks go bust. A few large investors jump off bridges. Heck, there are plenty of bridges in Europe. What’s the trouble?

Bill Bonner
for The Daily Reckoning