Tag Archives: Sovereign debt

There’s a major sovereign debt crisis looming, by Simon Black

The only mystery about the looming sovereign debt crisis is why its taken so long to arrive. From Simon Black at sovereignman.com:

At the turn of the century in the year 1300, the Republic of Florence’s public debt was quite manageable at just 50,000 gold florins. That’s less than $100 per capita in today’s money.

By 1338, after a series of costly wars and expensive public works projects, Florence’s debt had ballooned to 450,000 gold florins. Four years later (after yet another war) it had grown to 600,000 gold florins.

This was crippling to public finances given that the government of Florence was paying between 10% and 15% interest on its debt.

To make matters worse, some of Florence’s most prominent banks had made bad loans to foreign governments– most notably to King Edward III of England, who had suffered terrible defeat against France in what would become known as the Hundred Years War.

Edward would ultimately default on his Italian bank loans, sparking a terrible banking crisis in Florence.

News traveled quickly that the most powerful financial center in Europe was in trouble. The government was near ruin, and the banks were collapsing.

And then came the plague.

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Why Argentina Will Never Dollarize, by Bianca Fernet

It’s an Argentine male thing the rest of the world doesn’t understand. From Bianca Fernet at wolfstreet.com:

If Argentina possessed the dedication to logic and collective will to do something so drastic, they would not be in this predicament in the first place.

Bianca Fernet was “born” in 2011 out of my frustration with coverage of Argentina’s economy that I felt missed the point and demonstrated a vast chasm between reality. Frankly, everyone else didn’t know what they were talking about so I felt a moral obligation to jump into the fray.

It is perceived moral obligation that has lured me back behind my cheeky pseudonym to opine on Argentina’s current economic malaise. I’m going to start with the idea that Argentina will replace the peso with the US dollar, which is making the rounds in the Wall Street Journal, this article on Forbes, and pretty much every think tank whoring themselves around for a slice of the action.

Let me be clear – anyone who holds this opinion has zero idea what they are talking about and may have never met an Argentine in their lives.

Argentina will never ever dollarize despite there being a strong economic case in favor of doing so because it is run by Argentines. If Argentina possessed the dedication to logic and collective will to do something so drastic, they would not be in this predicament in the first place. Again. Argentines are neither swayed nor convinced by strong logical cases.

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No Lifeboats, by Robert Gore


Who has the most to gain from low and negative interest rates? Obviously debtors. The world’s biggest debtors are governments, with the US government number one. Debt today is like a listing ship. The objective of governments is to get themselves to the part of the ship that’s highest out of the water—the bridge—and cram everyone else below decks, submerged. The ship will sink, but governments and their cronies will let the other passengers drown before they breathe their last.

The real purpose—the only one that matters—of governments and central banks’ machinations since the financial crisis has been to finance governments. The world stood on the edge of the debt contraction abyss. Debt had reached an unsustainable level. Economies could no longer bear the load of interest payments and principle repayment. The marginal value of most debt, particularly that which funded consumption, had gone clearly negative. Even the value of debt incurred to fund “investment” was dicey, since much of that investment was actually speculation in disguise: house flipping, leveraged mortgage security arbitrage, share buybacks, and the like. The financial crisis was the iceberg rending the hole in the hull. Since then, the hole has only grown.

The bridge knows the vessel is taking on water and sinking. Sovereign debt has been monetized and interest rates driven to subzero so governments can buy themselves a little more time. Savers and those living off of fixed income investments were steerage, the first to be sacrificed. For them, the future of diminished consumption that everyone says is inevitable—but nobody seems to believe will ever happen—has arrived. They’ve been told to go to the hold and await further instructions while the central bank pumps bail away, but they’re up to their necks in cold, fast-rising water.

Chest deep and next to be sacrificed are aggregate pools of savings—pension funds and insurance companies. They have to generate a return and cannot survive if they receive no interest income on their bond investments. Underfunded pensions have thrown states, municipalities, and Puerto Rico into financial turmoil. The rates of return they had assumed, in most cases 7 percent or greater, are unavailable in any kind of prudent investment. Imprudent investments offer higher returns, but reluctance to embrace them is rational given multiple crashes in junk bond, equity, and real estate prices since the turn of the century. Insurance companies can at least raise their rates, but in many cases pension contributions are fixed by either law or contract, and can’t be changed without political push back from beneficiaries and other interested parties. Taxpayers are balking at calls to increase their support.

Mis-priced interest rates are also submerging the real economy. The artificial rate distortion produced by central banks’ cheap debt policies has led to malinvestment, glutted markets for both goods and services, and deflationary pressures that will be fully uncorked when debt finally contracts. The return on real investment has followed interest rates, it’s close to zero. The long-term trend rate of growth follows the real return on investment, so it too is falling towards zero (even by suspect official government reckonings) as the burden of servicing the mounting debt load rises.

When the economy gives up the ghost, it will be akin to the flooding of the crew’s quarters. There will still be a few high and dry on the bridge, but the ship cannot function without a crew. Washington and Wall Street are mostly high and dry, but it’s only a matter of time before the surge reaches them. Today’s anemic growth rates have been dragged down by debt. When they finally sport a negative sign (honestly accounted for, some—Europe’s, Japan’s, Russia’s and Brazil’s, et al.—already do), more debt will simply hasten the ship’s final plunge.

Expanding debt has allowed developed country sovereign bond and equity markets to reach record highs. Both, ultimately, are dependent on the real economy, so on many measures the divergence between financial asset prices and economic metrics has reached record extremes. By GAAP accounting or even by Wall Street’s preferred “adjusted” earnings, the stock market is trading at historically high multiples. Sovereign bond prices, which are the inverse of yields (higher prices equal lower yields), are at all time highs since negative yields are all time low yields.

Officially measured developed countries’ growth rates are trending to 1 percent, which is a statistical adjustment away from zero or negative growth. Most of that so-called growth is simply the debt-enabled pulling of future demand forward, which leads to less growth in the future. Cheap debt has blown up unsustainable bubbles in autos, student lending, and the housing market. Corporations have embarked on a borrowing spree, but unlike governments and central banks, they can’t manufacture fiat debt to repay their debts. Notwithstanding infinitesimal interest rates, credit quality has deteriorated to the worst level since the third quarter of 2009, and the default rate is climbing.

Cold water laps at the toes of the financial cronies. There will be more QEs, more ZIRP and NIRP, and inevitably helicopter money, but not because of any of the transparently specious reasons given for these quackeries. That includes the “cynical” one that they’re trying to keep stock and sovereign debt markets high and dry. Eventually stock markets will be sacrificed as the gap between stock prices versus earnings and economic performance grows ever wider and markets are asked to capitalize losses, not dwindling profits. Sovereign debt markets will be the last to go, because they can be supported by an endless supply of central bank fiat debt.

The cynical aren’t cynical enough. The quackeries will continue because they are the only way governments carrying unsustainable loads of debt and unfunded liabilities can be financed. It will not stop when economies improve because economies aren’t going to improve, they’re going to get worse. Look at Japan, which has journeyed the farthest down this road. Its central bank finances the government, buying all the government’s fiat debt with its own fiat debt. Just as the rest of the world’s economies are following Japan’s into zero and negative growth, they will follow its lead in finance. Sovereign debt and central bank debt exchange are all the potentates have to keep their heads above water a little longer.

Their cure is the disease. It is telling that nobody is talking about debt during the presidential campaign. Why stir up trouble? The candidates know that debt will sink the economy, and they’ve known so since at least 2008. It’s easier to find other economic scapegoats. Talking about debt would be like the bridge announcing over the public address system that the ship is sinking, the passengers are going to die, and all emergency measures will be directed towards keeping those on the bridge alive longer than everyone else. They can’t even tell the doomed to man the lifeboats. There are none.



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Sovereign Market Dislocation and Derivatives Turmoil, by Doug Noland

Don’t tell anyone on Wall Street, but Europe’s financial system is starting to implode. From Doug Noland at creditbubblebulletin.blogspot.com:

Seven UK mutual funds thus far have halted withdrawals and/or taken significant write-downs on fund asset values. Combined fund assets are about 20 billion pounds. Back in June 2007, it was the implosion of funds managed by Bear Stearns with about $20 billion of assets that set in motion the collapse of the mortgage finance Bubble. To be sure, bursting Bubble dislocations would have been less destructive had “Terminal Phase” excess not run roughshod throughout 2007 and well into 2008.

When I criticized the Fed’s reflationary policies back in 2009 – and initially warned of the emergence of the “global government finance Bubble” – the focus of my concerns was not hyperinflation or a dollar collapse. My worry was the likelihood for massive global fiscal and monetary stimulus to foster a systemic mispricing of “finance” – securities prices and Credit more generally. From this global macro perspective, the outcome has been my worst-case-scenario. Actually, policy measures and attendant pricing distortions have been far more extreme than I could have imagined.

Japanese 10-year JGB yields ended the week at negative 0.29%. German 10-year bund yields closed the week at a record low negative 0.19%, and Swiss yields were a record low negative 0.69%. French 10-year yields ended Friday’s session at an all-time low 10 bps. The Netherlands saw yields drop to zero. U.K. gilt yields sank 10 bps to a record low 0.73%. And despite stronger-than-expected job gains, Treasury yields closed the week at a record low 1.36%.

Italy, with three Trillion of sovereign debt measured at a problematic 135% of GDP (and growing), ended the week with 10-year yields at a record low 1.19%. Mario Draghi’s “whatever it takes” has had a most profound impact on Italian yields (down about 500bps since the summer of 2012). Yet despite collapsing borrowing costs, Italy nonetheless runs persistent budget deficits. And while the ECB has thus far succeeded in keeping Italy solvent, the same cannot necessarily be said for Italy’s troubled banking industry (see “Italy Watch” below).

From the Wall Street Journal (Giovanni Legorano): “In Italy, 17% of banks’ loans are sour. That is nearly 10 times the level in the U.S., where, even at the worst of the 2008-09 financial crisis, it was only 5%. Among publicly traded banks in the eurozone, Italian lenders account for nearly half of total bad loans.”

In a more normal market backdrop, Italy’s finances would today be in crisis. Surging sovereign yields and failing banks would have forced harsh but needed financial, fiscal and economic structural reform. This should have transpired years ago. These days there is perhaps some tension, but there’s no burning crisis in Rome. Prime Minister Renzi, while politically weakened at home, can use his government’s vulnerability to wield impressive power in Brussels and Frankfurt, especially post Brexit. After all, Italy could rather easily bring down the European banking system. Indeed, the Italians today hold sway over the euro currency, and Renzi knows he’s playing a strong hand.

July 6 – Reuters (Isla Binnie): “The difficulties facing Italian banks over their bad loans are miniscule by comparison with the problems some European banks face over their derivatives, Italian Prime Minister Matteo Renzi said… Speaking at a joint news conference with Swedish Prime Minister Stefan Lofven, Renzi said other European banks had much bigger problems than their Italian counterparts. ‘If this non-performing loan problem is worth one, the question of derivatives at other banks, at big banks, is worth one hundred. This is the ratio: one to one hundred,’ Renzi said.”

To continue reading: Sovereign Market Dislocation and Derivatives Turmoil


The Global Bubble Has Burst – “Will Tear At The Threads Of Society” by Doug Noland

Doug Noland understands debtonomics. From Noland at creditbubblebulletin.blogspot.com, as excerpted on zerohedge.com:

Bubble Economy or Not?

“The US economy has made tremendous progress in recovering from the damage from the financial crisis. Slowly but surely the labor market is healing. For well over a year, we have averaged about 225,000 jobs (gains) a month. The unemployment rate now stands at 5%. So, we’re coming close to our assigned congressional goal of maximum employment. Inflation which my colleagues here, Paul (Volcker) and Alan (Greenspan), spent much of their time as chairmen bringing inflation down from unacceptably high levels. For a number of years now, inflation has been running under our 2% goal, and we are focused on moving it up to 2%. But we think that it’s partly transitory influences, namely declining oil prices and the strong dollar that are responsible for pulling inflation below the 2% level we think is most desirable. So, I think we’re making progress there as well. This is an economy on a solid course – not a bubble economy. We tried carefully to look at evidence of potential financial instability that might be brewing and some of the hallmarks of that – clearly overvalued asset prices, high leverage, rising leverage, and rapid credit growth. We certainly don’t see those imbalances. And so although interest rates are low, and that is something that can encourage reach for yield behavior, I certainly wouldn’t describe this as a bubble economy.”

-Janet Yellen, April 7, 2016, International House: “A Conversation with Janet Yellen, Ben Bernanke, Alan Greenspan and Paul Volcker”

From my analytical perspective, unsustainability is a fundamental feature of “Bubble Economies.” They are sustained only so long as sufficient monetary fuel is forthcoming. Over time, such economies are characterized by deep structural maladjustment, the consequence of years of underlying monetary inflation. Excessive issuance of money and Credit are always at the root of distortions in investment and spending patterns. Asset inflation and price Bubbles invariably play central roles in latent fragility. Risk intermediation is instrumental, especially late in the cycle as the quantity of Credit expands and quality deteriorates. Prolonged Credit booms – the type associated with Bubble Economies – invariably have a major government component.

Japanese officials in the late-eighties recognized the risks associated with their Bubble economy and moved courageously to pierce the Bubble. Outside of that, few policymakers have been even willing to admit that Bubble Dynamics have taken hold in their systems. Apparently, only in hindsight did U.S. monetary authorities recognize the Bubble component that came to exert pernicious effects on the U.S. economy in the late-eighties, later in the nineties and again in the 2002-2007 mortgage finance Bubble period. I would strongly argue that the U.S. has been in a “Bubble Economy” progression for the better part of thirty years, interrupted by financial crises relatively quickly resolved by aggressive governmental reflationary measures. And each reflation has been more egregious than the previous, with resulting booms exacerbating underlying financial and economic maladjustment.

Chair Yellen stated that the U.S. “is an economy on a solid course – not a bubble economy” – “we tried carefully to look at evidence of potential financial instability that might be brewing.” That the Fed has for seven post-crisis years clung to near zero rates and a $4.5 TN balance sheet (with reassurances that it can grow larger) argues against such claims. That the Fed rather abruptly backed away from its 2011 “exit strategy” and repeatedly postponed “lift off” due to market instability rather clearly demonstrates the Fed’s underlying lack of confidence in the soundness of the markets and real economy.

I have argued that the more systemic a Bubble the less obvious it becomes to casual observers. By the late-nineties, the “tech” Bubble had turned rather conspicuous (although the Fed and the bulls still rationalized with claims of New Eras and New Paradigms). While having quite an impact on the technology, telecom and media sectors, these relatively narrow Bubble distortions had yet to cultivate more general structural impairment throughout the economy.

The mortgage finance Bubble was a much more powerful Bubble Dynamic, clearly in terms of Credit expansion, economic imbalances and systemic impairment. Alan Greenspan nonetheless argued that since real estate was driven by local factors, a national housing Bubble was implausible. Only in hindsight was the degree of systemic “Bubble Economy” maladjustment recognized.

It’s now been seven years since my initial warning of an inflating “global government finance Bubble” – the “Granddaddy of All of Bubbles.” This Bubble did become systemic on a globalized basis, ensuring the strange dynamic of a somewhat less than conspicuous global Bubble of historic proportions. Over the past eight years, global Credit growth has been unprecedented – driven by an extraordinary expansion of government borrowings. The inflation of central bank Credit has been simply unimaginable. Global asset inflation has been extraordinary – especially in securities markets and real estate.

The expansion of Chinese Credit has been greater than I previously imagined possible. Hundreds of billions – perhaps Trillions – have flowed out of China, with untold amounts flowing into the U.S. (real estate, securities and M&A). For that matter, I believe huge inbound flows have been inflating U.S. securities and some real estate markets, especially “money” fleeing bursting EM Bubbles.

Indeed, extraordinary international financial flows are fundamental to the global government finance Bubble thesis, flows that I believe are increasingly at risk. Along with Bubble flows from China and out of faltering EM, I believe speculative flows grew to immense proportions. And, importantly, the massive global pool of destabilizing speculative finance has been inflated by the proliferation of leveraged strategies. Chair Yellen may not see “high leverage,” yet on a globalized basis I strongly believe speculative leverage reached new heights over recent years. “Carry trade” speculation – borrowing in low-yielding currencies (yen, swissy, euro, etc.) – has proliferated over recent years, especially after the 2012 “whatever it takes” devaluations orchestrated by the European Central Bank and Bank of Japan.

To continue reading: The Global Bubble Has Burst – “Will Tear At The Threads Of Society”