I am not sure whether the global bond market would be able to fund the $6 trillion of the Obama fiscal package. The world is indeed running out of capital.
Unless this capital is forthcoming, a clutch of countries will prove unable to roll over their debts at a bearable cost. Countries most at risk of default are those that cannot print money as they do not have a national currency (Euro nations), and those who have borrowed abroad (Eastern Europe).
Traders already whisper that some governments are buying their own debt through proxies at bond auctions to keep up illusions - not to be confused with transparent buying by central banks under quantitative easing. This cannot continue for long.
Commerzbank said every European bond auction is turning into an "event risk". Britain too finds itself some way down the AAA pecking order as it tries to sell 220 billion pounds of Gilts this year to irascible investors.
US hedge fund Hayman Advisers is betting on the biggest wave of state bankruptcies and restructurings since 1934. The worst profiles are almost all in Europe - the epicentre of leverage, and denial. As the IMF said last week, Europe's banks have written down 17% of their losses - American banks have swallowed half.
It looked easy for Western governments during the credit bubble, when China, Russia, emerging Asia and petro-powers were accumulating $1.3 trillion a year in reserves, recycling this wealth back into the US Treasuries.
The tap has been turned off. These countries have become net sellers. Central bank holdings have fallen by $248 billion to $6.7 trillion over the last 6 months. The Oil crash has forced both Russia and Venezuela to slash reserves by a third.
Japan’s $1.5 trillion state pension fund (World’s Biggest) dropped a bombshell this month. It will start selling holdings of Japanese state bonds this year to cover a $40 billion shortfall on its books. So how is the Ministry of Finance going to fund a sovereign debt expected to reach 200% of GDP by 2010 (also the World’s Biggest) even assuming that Japan’s industry recovers from its 38% crash?
Japan is the first country to face a shrinking workforce in absolute terms, crossing the dreaded line in 2005. Its army of pensioners is dipping into the collective coffers. Japan’s saving rate has fallen from 14% of GDP to 2% of GDP since 1990. Such a fate looms for Germany, Italy, South Korea, Eastern Europe and perhaps eventually China.
So where is the $6 trillion going to come from this year, and beyond? For now we must fall back on the Fed, the Bank of England, and various central banks, World Bank – nota-bene and rely on printed money (QE) to pay for education, infrastructure and administration. It is necessary (Alas!!) to stave off debt deflation. But it is also a slippery slope, as Fed hawks keep reminding us their chairman Ben Bernanke. One wonders if Mr. Bernanke regrets saying so blithely that Washington can create unlimited dollars “at essentially no cost”.
The crux of the problem is not sub-prime or mortgage loans or this and that bank but the government. Governments around the world allowed their banking system to grow unchecked, in some cases going into an untenable liability for the host country. A disturbing number of states look like Iceland once you dig into the entrails, and most are in Europe where liabilities average 4.2 times the GDP.
The G20 deal to triple the IMF’s fire fighting fund to $750 billion buys time for the likes of Ukraine and Argentina. But the deeper malaise is that so many of the IMF backers are themselves exhausting their credit lines and cultural reserves.
Great bankruptcies change the world. Spain’s default under Philip II ruined the Catholic banking dynasties of Italy and South Germany, Shifting the locus of financial power to Amsterdam. Anglo-Dutch forces were able to halt the Counter-Reformation, free Northern Europe from absolutism, and break into North America.
Who knows what revolution will come from this crisis if it ever reaches defaults.
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