Next Thing to worry about: Country Default

[M Faber]

The Next Thing You Need To Worry About Is The PIIGS



After every financial crisis there's a sovereign debt crisis. Countries that borrowed too much during the boom times start struggling to pay their competitors back, and eventually some of them default.

The countries most likely to blow up this time around are the "PIIGS": Portugal, Ireland, Italy, Greece, and Spain. One or more of them, will likely default in the next couple of years. And, that could result in the death of the Euro currency.

Longer-term Japan and the US are in line for the same fate.

The US crisis won't hit us this year or next year. But within 5-10 years, the United States will be forced to quietly default on its debt, most likely by printing money and destroying the value of the currency.

The main problem comes down to two things: 1) ballooning debts and 2) future interest costs.

In the past decade, the U.S. government's total debt and liabilities have gone through the roof, especially when Fannie, Freddie, Medicare, and Social Security are taken into account. This trend is unsustainable, and it will correct itself only through a rapid acceleration of economic growth and tax revenues, a new-found financial discipline, or a crisis--or a combination of all three.

The second problem is interest costs. Right now, the government's debt and deficits aren't creating an undue burden because the government can borrow so cheaply. Eventually, however, as the country's financial situation gets weaker, interest rates will likely rise, and our interest costs will go through the roof.

US annual interest costs currently amount to 12% of the government's tax revenue. Within five years these costs will soar to 35% of tax revenue. This will force the government to cut spending (unlikely) and/or frantically print money.

[Sapphire Capital]

see attachement first

Rolfe Winkler argues that - in the short-run - the PIIGS countries (Portugal, Ireland, Italy, Greece and Spain) will slash their budgets and get bailed out by the EU.

Simon Johnson thinks that the weakening Euro caused by the PIIGS' woes will hurt American exports (weaker Euro equals stronger dollar), and could lead to problems for leading global banks.

Other commentators fear that the PIIGS' crisis has as much potential as a financial "contagion" as the subprime meltdown and the failure of Lehman.

But for the long-term view, we need a little more perspective. One of the world's leading economic historians - Harvard professor Niall Ferguson - says:

The economists are ill qualified to analyse the current economic situation since they lack the overview of historians such as himself.

"There are economic professors in American universities who think they are masters of the universe, but they don't have any historical knowledge. I have never believed that markets are self correcting. No historian could."

Ferguson warns of huge government debts threatening the solvency of entire nations:

"The idea that countries don't go bust is a joke... The debt trap may be about to spring ... for countries that have created large stimulus packages in order to stimulate their economies."

But whether or not large nations actually go bankrupt, one thing is clear . . . Larry Summers, Ben Bernanke, Tim Geithner and their foreign counterparts have failed.

As I noted in December 2008:

BIS [the Bank of International Settlements - the "Central Banks' Central Bank] points out in a new report that the bank rescue packages have transferred significant risks onto government balance sheets, which is reflected in the corresponding widening of sovereign credit default swaps:

The scope and magnitude of the bank rescue packages also meant that significant risks had been transferred onto government balance sheets. This was particularly apparent in the market for CDS referencing sovereigns involved either in large individual bank rescues or in broad-based support packages for the financial sector, including the United States. While such CDS were thinly traded prior to the announced rescue packages, spreads widened suddenly on increased demand for credit protection, while corresponding financial sector spreads tightened.

In other words, by assuming huge portions of the risk from banks trading in toxic derivatives, and by spending trillions that they don't have, central banks have put their countries at risk from default.

Nothing has changed. As former chief Merrill Lynch economist David Rosenberg writes this week:

First the governments bail out the banks who were (are) basically insolvent. Then these governments, especially in Europe, see their balance sheets explode and face escalating concerns over sovereign default. The IMF now predicts that the government debt-to-GDP ratio in the G20 nations will explode to 118% by 2014 from pre-crisis levels of around 80%.

Now, the ball is put back onto the banks because many have exposure to the areas of Europe that are facing substantial fiscal problems right now. According to the Wall Street Journal, U.K. banks have $193 billion of exposure to Ireland. German banks have the same amount of exposure and an additional $240 billion to Spain. Many international bond mutual funds also have sizeable exposure to sovereign debt of Portugal, Ireland, Greece and Spain as well. Contagion risks are back. Stay defensive and expect to see heightened volatility.

In a nutshell, toxic assets have basically been swept under the rug in the hopes that we will outgrow the problem. Leverage ratios across every level of society are still reaching unprecedented levels as the public sector sacrifices the sanctity of its balance sheet in its quest to stabilize the dubious financial position of the household and banking sectors in many parts of the world.

Whatever bad assets have been resolved have almost entirely been placed on the books of governments and central banks, which now have their own particular set of risks, as we have witnessed very recently in places like Dubai, Mexico, and Greece, not to mention at the state and local government level in the United States. We simply have not seen a reduction in the percentage of properties with mortgages that are “under water”, hence the FDIC has identified 7% of banking sector assets ($850 billion) that are in “trouble”, so how can it possibly be that the financial system is anywhere close to some stable equilibrium?

When accurately measured, including the shadow inventory from bank foreclosures, there is still nearly two year’s worth of unsold housing inventory in the United States, and commercial vacancy rates are poised to reach unprecedented highs, and this excess supply is bound to unleash another round of price deflation and debt defaults this year. The balance sheets of governments are rapidly in decline across a broad continuum, and it is particularly questionable as to whether Europe is in sound enough financial shape to weather another banking-related storm.

The global economy is set to cool off. Not only is China and India warding off inflation with credit tightening measures but most of the fiscal and monetary stimulus thrust in the U.S.A. and Canada is behind us as well. And, the fiscal tourniquet is about to be applied in many parts of Europe, especially the PIIGS (referring to Portugal, Ireland, Italy, Greece and Spain — these countries account for a nontrivial 37% of Eurozone GDP). Greece’s GDP has already contracted by 3.0% YoY, as of Q4, and is expected to contract 1.1% in 2010 and 0.3% in 2011 as a 13% deficit-to-GDP ratio is sliced from 13% to 3% (assuming this fiscal goal can be achieved politically). Portugal has a 9.2% deficit-to-GDP ratio that is in need of repair and Spain has a deficit ratio that is even worse, at 11.4% of GDP.

The bottom line is that even if the fiscally-challenged countries of Europe do not end up defaulting, or leaving the Union, the reality is that they will have to take draconian measures to meet their financial obligations. Devaluation was the answer in the past in Greece but it cannot rely on that quick fix this time around without leaving EMU and if it did, then that could make it even harder to service its Euro-denominated debts — at least not without a restructuring. And, if Greece did attempt at a debt restructuring, rest assured that Italy, Spain, Portugal and Ireland would be next — we are talking about a combined $2 trillion of potential sovereign debt restructuring that would more than triple the $600 billion direct cost of the Lehman bankruptcy.

This poses a hurdle over global growth prospects at a time when Asia will feel the pinch from the credit-tightening moves in China and India. And heightened risk premia will also exert a dampening global dynamic of their own in terms of economic decision-making by businesses and households alike. The intense sovereign risk concerns are not limited to Europe either. In the U.S.A. we saw CDS spreads widen out to their highest levels since the equity markets were coming off their lows last April. According to the FT, the Markit iTrax SivX [sic] index of CDS on 15 western European sovereign credits rose above 100bps on Friday for the first time ever.

Attachments:

[MMM]

and what about the US States, they are even worse:

Think the PIGS Are in Trouble? These 7 U.S. States Could Be Heading for Something Worse
Published on 02-10-2010

Source: Seeking Alpha

The inevitable coming of the sovereign debt panic finally engulfed Europe this week as the derisively (or perhaps affectionately) named PIGS spilled their slop on the continent. But Portugal, Ireland, Greece, and Spain are hardly worthy of so much attention. In truth, they are little more than the currently favored proxies among the leveraged speculator community (cough) for the larger problem of all sovereign debt. Indeed, the credit default swaps on these smaller European satellite states were not alone this week in making large moves higher. UK sovereign risk rose strongly, and so did US sovereign risk. With a downgrade warning from Moody’s to boot.

Notable among three of the PIGS are their relatively small populations, and small contributions to either world or European GDP. While Spain has a population over 45 million, Portugal and Greece have populations roughly equal to a US state, such as Ohio–at around 10 million. And Ireland? The Emerald Isle has a population similar to Kentucky, at around 4 million. While the PIGS are without question a problem for Europe, whatever problems they present for Brussels are easily matched by the looming headache for Washington that’s coming from large US states such as California, Florida, Illinois, Ohio, and Michigan.

I’ve identified seven large US states by four criteria that are sure to cause trouble for Washington’s political class at least for the next 3 years, through the 2012 elections. These are states with big populations, very high rates of unemployment, and which have already had to borrow big to pay unemployment claims. In addition, as a kind of Gregor.us kicker, I’ve thrown in a fourth criteria to identify those states that are large net importers of energy. Because the step change to higher energy prices played, and continues to play, such a large role in the developed world’s financial crisis it’s instructive to identify those US states that will struggle for years against the rising tide of higher energy costs.

First, let’s consider a large state that didn’t make my list. Texas didn’t make the list because its unemployment rate has not risen high enough to reach my cutoff: a state must register broad, U-6 underemployment above 15%, and currently Texas has only reached 13.7% on that measure. Also, Texas’s total energy production nearly perfectly matches its total energy consumption. Of course, Texas has indeed had to borrow more than a billion dollars so far to pay unemployment claims, thus technically bankrupting its unemployment trust fund. That meets my criteria. But, it’s instructive to note Texas’ energy production capacity in this regard, as that produces dollars. And one of the big reasons US states are under so much pressure, like their European counterparts, is that they cannot print currency. Being able to produce oil and gas is the next best thing to printing currency. So, Texas doesn’t make my list.

The seven states to make my list are California, Florida, Illinois, Ohio, Michigan, North Carolina, and New Jersey. Each has a population above 8 million people. Each has had to borrow more than a billion dollars, so far, to pay claims out of their now bankrupt unemployment insurance fund. Also, each state currently registers broad, underemployment above 15% as indicated by the U-6 measure for the States. And finally, each state is a large net importer of either oil, natural gas, electricity, or all three of these energy sources.

Let’s consider the overall predicament for residents of states like California, with its epic housing bust, Ohio and Michigan at the end of the automobile era, or North Carolina and New Jersey in light of the financial sector’s demise. Not only have states such as these permanently lost key sectors that once drove their economies, but, residents in these states are over-exposed to structurally higher energy costs. The prospect for wage growth in the United States is now dim. We are already recording year over year wage decreases in real terms. The culprit? Energy and food costs. My seven states are squeezed hard at both ends: no wage growth at the top, and no relief through cheaper energy costs at the bottom.

US wage growth in real terms has been stagnant for years. And the most recent decade of higher oil prices has been particularly punishing to states over-leveraged to the automobile like California, Florida, and North Carolina where highway and road systems dwarf public transport. While it’s true that states like Ohio and California produce some oil and gas, the size of their populations overwhelm any production with outsized demand for electricity and gasoline. In contrast, and as I mentioned, it will be revealing to see how this depression ultimately plays out in such states as Colorado, New Mexico, Wyoming, Oklahoma, North Dakota, and Louisiana which are all net exporters of energy.

Were it not for peak oil, gasoline prices would have fallen to a dollar during this depression as oil returned to the lows of the late 1990’s–if not even lower. Petrol at 90 cents a gallon would begin to chip away at the painfully decreasing spread between punk wages and energy input costs, currently endured by underemployed Americans. Natural gas and coal prices are also much higher than they were at the lows of the 1990’s. And I need not remind: while energy prices are very 2010, the American workforce has lost so many jobs that our labor force has indeed returned the 1990’s.

21st century energy prices overlaid on a 20th century economy? That’s no fun at all. The mainstream economics profession, perhaps unsurprisingly, still does not pay enough attention to the interweaving of long-term stagnant wage growth, higher energy inputs, and the resulting credit creation that OECD countries took as the solution to resolve that squeeze. Given that one out of eight Americans takes food stamps, a visit to states like Illinois, Florida, Ohio, and North Carolina would reveal that the difference between 15 dollar oil and 75 dollar oil, and 2 dollar natural gas and 5 dollar natural gas is large.

My seven states of energy debt represent a full 35% of the total US population. As with other US states, they face looming policy clashes between protected state and city workers on one hand, and the growing ranks of the private economy’s underemployed on the other. The recent circus at the LA City Council meeting was a nice foreshadowing that the days of unlimited borrowing by governments–against future growth based on cheap energy–is coming to an end. Washington can print up dollars and fund these states for years, if it so chooses. But just as with the 70 million people in Portugal, Italy, Greece and Spain, the 108 million people in these seven large states are probably facing even higher levels of unemployment as austerity measures finally slam into their cashless coffers, and reduce their ability to borrow.

[cml1234]

Germany and Spain have both recently stated they want to break away from the EURO.

[Sapphire Capital]

I doubt that, I mean sure they discuss it, just like Bavaria voted against the German Constitution after the war and did not want to be a member of the German Republic is discussing to break away and will never do, to strongly tied together, Germany may on the face pay more into the European Union and the cover of the Euro than it gets out of it but thats just the face, in reality the German economy is so intertwined with the other european members that they can not step out the Euro without loosing a lot more than it costs. I believe Spain is the same.