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Jim Cook

 

RUNAWAY SOCIAL SYMPATHY

Every once in a while I switch the TV channel from Fox to CNBC to see what the liberals are saying.  After listening awhile I get a deep sense of hopelessness and foreboding for our country.  The most important thing for the left is giving money to people.  They are happy to see the growth of food stamps, disability payments, housing subsidies, free healthcare and all the other welfare benefits.  They utterly fail to see the damage it is doing to the recipients.  Whole cities that once flourished have deteriorated into rotting eyesores populated with shambling hulks of chemically dependent drones.  These people are no longer employable.  They have become incompetent and helpless and the liberals can’t see that it’s their doing.

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The Best of Jim Cook Archive

 
Best of Puru Saxena
August 24, 2011
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Let’s face it; many of the world’s ‘developed’ nations are insolvent and the writing is on the wall.  Either these indebted states will default or they will try and inflate their currencies into oblivion.

As far as the US is concerned, it still has the privilege of owning the world’s reserve currency and its central bank can always create more dollar bills out of thin air.  Thus, it is unlikely that the US will ever default on its debt obligations.

Unfortunately, thanks to the brilliant invention of the single currency, the European states do not have the luxury of printing or debasing their currencies.  Accordingly, their hands are tied and they are now at the mercy of their foreign friends.  Make no mistake, the Greeks, Portuguese and the Italians simply do not have the choice of printing drachmas, escudos or lire.  Therefore, unless their creditors accept some big haircuts on their loans, sovereign defaults are inevitable. 

Politicians can lie all they want, but the truth is that the debt obligations of these European nations are simply too large relative to the size of their economies.  In Greece, government debt now represents almost 160% of GDP and the average yield on Greek debt is around 15%.  Thus, if Greece’s debt is rolled over without restructuring, its interest costs alone will amount to approximately 24% of GDP.  In other words, if debt pardoning does not occur, nearly a quarter of Greece’s economic output will be gobbled up by interest repayments!  Looking at this simple maths, it is obvious to us that unless the Germans or the French comes to its rescue, Greece will default within 2-3 years. 

Figure 1 captures the sorry state of affairs in Europe and highlights the continent’s huge debt overhang.  Topping this infamous list is Greece and as you can see, Italy, Ireland, Portugal and Belgium complete the top five slots.  Moreover, it is interesting to note that only five member states have abided by the EU Stability Pact’s debt ceiling of 60%!

Figure 1: Euro countries - government debt to GDP ratio

chartps

Source: European Commission
In our view, Greece’s economy is small enough that the Germans and/or the French may pick up the tab. So, we are not especially concerned about an immediate sovereign default by Greece. 

Unfortunately, the Italian economy is a whole lot bigger and its government debt comes in at a staggering Euro 1.9 trillion (US$2.7 trillion).  At the time of writing, the 10-year Italian bond yield has jumped to 5.76% and if it continues to rise, elementary maths tells us that Italy will have a serious problem on its hands. It is noteworthy that the recent surge in Italy’s bond yields will increase borrowing costs, which the government estimates will total Euro 75 billion this year or nearly 5% of GDP. According to our estimates, if the average interest rate on Italy’s debt rises to 6% by 2014, annual financing costs will jump to Euro 110 billion or almost 7.5% of GDP.  Given the sheer size of the sums involved, it is highly unlikely that the German and/or the French citizens will allow their governments to pick up Italy’s tab.  Thus, it is our contention that Italy will ultimately prove to be a bigger nightmare than Greece.  Nonetheless, we suspect that any sovereign default will not occur anytime soon.  Instead, some of the troubled European states will default towards the end of the next big bear market, which seems to be several months away.

Puru Saxena publishes Money Matters, a monthly economic report, which highlights extraordinary investment opportunities in all major markets.  In addition to the monthly report, subscribers also receive “Weekly Updates” covering the recent market action. Money Matters is available by subscription from www.purusaxena.com