When All Roads Lead to Default

Friday may have been a key turnaround day. Stocks fell 166 points on the Dow. Gold leaped $22.

What’s up? Hard to say… We’ll have to see what happens this week.

A falling gold price means people think things are under control…that they believe the present system works…and that it will deliver growth without excessive inflation.

When people lose confidence in the system, on the other hand, the gold price goes up.

By the end of last week, people must have been losing confidence.

Egypt seemed on the brink of a major blow-up, possibly destabilizing the entire mid-east.

And from Japan came more disturbing news:

“S&P Downgrades Japanese Debt,” said the headline. Standard and Poor’s said Japan had no plausible plan for keeping itself from bankruptcy.

The country has the highest debt to GDP ratio in the world. And it just keeps adding debt.

Is that a problem? Lenders – mostly the Japanese themselves – don’t seem to think so. They lend money to the Japanese for 10 years and ask only 1.24% interest. Can you imagine? If the yen lost only 2% per year – which is the TARGET in most advanced economies – the real interest rate would be negative. Meaning, the lender would lose money every year.

And how will the Japanese repay the money? Lenders are putting up money to a borrower who, as the S&P puts it, has ‘no plausible plan’ for paying it back. And asking only 1.24% interest. What are they thinking? Are they thinking at all?

Saving rates in Japan are falling. People are getting older. More people are retiring than entering the workforce. How can this movie possibly have a happy ending?

Meanwhile, here’s another headline. This one probably didn’t rattle investors. But it should have shown them where we’re headed:

Spain to Raise Retirement Age to 67

MADRID – Spain’s government and main labor unions agreed on Thursday to raise the retirement age as part of an overhaul of the country’s pensions system, averting threatened organized protests and responding to investors who have been demanding that Spain clean up its public finances.

After a year of negotiations, the draft deal ensures that Spain’s normal retirement age will rise to 67 from 65. As part of a compromise, however, the government agreed that workers could retire at 65 if they had contributed to the state pensions system for at least 38.5 years. The agreement is also intended to cut the cost of future pension payments by basing the calculation for such payments on a worker’s last 25 years of earnings, rather than the 15 years under current law.

Pension reform has been a political hot potato in several European countries, including France, which was hit last autumn by a nationwide strike and protest movement before the government won support in Parliament for its plan to raise the minimum retirement age to 62 from 60. Similarly, Greece was the scene of serious unrest after its government also agreed last June to radical changes to its retirement program – including cuts in benefits and curbs on early retirement – as part of changes promised by Athens in return for a €110 billion, or $150 billion, bailout.

Like many other Western countries, Spain is facing mounting difficulties in supporting the cost of an aging population, at a time when its economy is showing little signs of recovering from the worldwide financial crisis. Last year was the first in which Spain’s pension system did not manage to run a surplus.

What is this? It’s a default. Spain is defaulting on promises made to its working classes.

We’ll see a similar default in all the advanced, social welfare economies. America included. They all made promises they can’t keep. Now, they have to default…in many different ways.

Some will cut back fast on promises in order to protect their credit. Others will let themselves be pushed to the wall – like Argentina in ’01. They will not willingly cut back…they will be forced to do so. Then, when they run out of money, they will be unable to keep their promises. In desperation, they will seize assets and cause all sorts of mischief – just like the Argentines did.

Still others…like a ruined man reaching for a loaded pistol…will turn to the printing press.

It doesn’t matter how many bailouts you give them. It doesn’t matter how far down the road you “kick the can.” All will default. The only questions are how and when…

Bill Bonner
for The Daily Reckoning