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'Sovereign Debt' was a phrase only found
in the arcane prose of economists writing in academic journals until relatively
recently. Since the 2008 near death experience of many large banks,
internet blogs carried commentary on the subject, but only very recently has
the mainstream media tuned into the issue of sovereign debt. Quite
simply, they could not ignore the omnipresent financial clouds any longer.
What is 'Sovereign' Debt?
In its simplest form, ' sovereign' debt
means 'government' debt, the financial debt of a country. It
usually also means the accumulated debts of government sub entities such as
states, provinces, municipalities, agencies, boards and commissions for which
the senior government is ultimately responsible.
While existing government debt is the
problem for today, contingent liabilities for promises of future services to
its citizens dramatically complicates the current debt problem.
Unfunded future liabilities are obligations which represent the one ton
gorilla peering through the front window of many nations.
What does Debt 'Default’ Mean?
'Default' is a word similar to the word
‘bankrupt’ when referring to the inability of a private
individual, business or institution which fails to meet its financial
obligations. When debt is unable to be repaid, a formal declaration of
this fact triggers a bankruptcy in a court of law. In the case of government,
the inability to pay its accumulated debt from past spending, because it
can’t raise adequate taxes or borrow additional funds means that
government has become insolvent and thus forces a formal default on its debt.
Which Countries are Likely to Default on
their Debt?
Daily revelations about the debt
travails of Greece has trained the debt spotlight on other nations which are
infected by a similar set of debilitating financial symptoms. Portugal,
Ireland, Italy and Spain have boarded Greece’s sinking ship. These
PIIGS are increasingly characterized as merely the frontrunners in a European
marathon which could easily involve many more nations before long. But these
five Euro member nations are only a small part of the sixteen Euro countries which
are shackled by the constraints of a single currency. While Germany, Holland
and a few other countries seem financially sound, many other members
aren’t so well endowed.
To the Euro club can be added many other
countries belonging to the larger European Union economic zone as well as
select former Soviet satellite nations of Eastern Europe. More
surprisingly still is how vulnerable certain very large first world economies
have become. While it seems implausible, the United Kingdom, Japan and the
United States are also rapidly attaining the unflattering attributes of the
PIIGS, which means they too could be snared into the debt and default trap
before it snaps shut!
What Makes Countries Susceptible to Debt
Default?
Too much debt, but what is too
much? Annual deficits exceed 3% of the Gross Domestic Product is the
standard the European Central Bank sets for
its 16 ‘Euro’ member
countries. 25 of 27 European nations are currently
running annual deficits in excess of 3% of GDP. Ireland is at 14.3 %, France
stands at 8% and Germany is at 6%. Greece stands at 12.5% of GDP.
What this means is that government spending continues to escalate rapidly
while their economies, upon which taxes are levied, are far less robust.
Debt accumulated from excessive spending
in previous years is the cause of the looming financial crises. Economists
Reinhart and Rogoff recently published
comprehensive new research covering two hundred years of economic history
which concluded that countries which reached debt levels of 90% of
their GDP, rapidly descended into the flames of default hell. Many of the
nations noted above are already close to this level of debt while others are
turbo charging toward the 90% precipice of no return.
Given that current interest rates are at
multigenerational lows, it seems entirely plausible that when interest rates
start rising, the burden of higher interest rates on the bonds issued to
secure additional borrowed funds, will become virtually unserviceable. If
interest rates were to double from their current 3% levels
on 10 year maturing bonds or double from the
current 5% on 30 year bonds, most of these nations would
very quickly reach the brink of default.
What are the Common Characteristics of
Debt Default Candidates?
With the exception of Japan and the
United States, all other default candidates are European. Many have advanced
first world economies with high standards of living. Most share
political traditions and values whereby the welfare state ensures high living
standards and guarantees protection and security against most of life’s
challenges for their citizens. Cradle to grave security requires ever
higher levels of savings and investments which result in wealth generation
and serves as a growing tax base sufficient to deliver on promises of current
and future benefits, especially with the universal demographic of rapidly
aging populations.
Virtually all countries subject to
concerns about default show shortfalls in economic growth resulting in anaemic tax revenues requiring more credit and borrowing
in order to compensate. Now that credit is either tightening or isn’t
available and interest rates are rising again, this game of spend and borrow
is about to end.
Can Debt Default be Avoided?
We are all faced with a daily deluge of
metaphors by virtue of media coverage of the evolving financial carnage in
Greece. “Dominos’, ‘Deck of Cards’,
‘Greek Contagion’, ‘Greece is the Precedent’ and ever
more alarming and inventive terms.
We might remember the alarm we
experienced less than 2 years ago when the largest investment banks
seemed to be taking the entire world into a financial abyss. Over US
$700 Billion was allocated immediately by the U.S. Congress to the Treasury
Secretary for whatever mitigation measures were thought necessary. The Federal
Reserve Board followed with many other exceedingly inventive measures costing
US $Trillions of borrowed taxpayer dollars designed to lubricate creaky
financial joints. This was government bailing out private institutions
in the financial sector.
What happens, however, when
governments themselves require emergency financial assistance? Greece
represents only 2.5 percent [%] of the Euro club GDP economy, yet it has
taken weeks to arrange US $140 Billion of assistance. What happens when
countries with much larger economies and needs ask for assistance? The
International Monetary Fund is making itself visible, but after the recent
levy on member nations, they have only managed to bring their kitty from US
$50 to $500 Billion. Spain, Italy or the UK could mop that amount up in short
order. Then what? Financially broken nations will be funding other
financially broken nations. That is what the almost US $1 Trillion joint
Euro/EU/IMF hurried announcement of Sunday May 8th represents. Does that seem
like a workable plan? What happens when the banks who are creditors of
these nations line up for assistance again, as they did in late 2008? Who
bails them out this time when their own governments are broke?
A cynic might even suggest that
sovereign debt bailouts are not primarily designed to assist nations nearing
default. Rather financial assistance to nations simply allows them to pay
their obligations to their foreign bank creditors who hold the bonds of
the nations nearing default. In other words, collective efforts from the
likes of the French, German, British, Spanish governments and
others, is merely an elaborate ruse to keep their own banks solvent from the
impending default of other nations.
The staid and highly regarded Bank of
International Settlements based in Switzerland recently issued a sobering
report in which it stated the need for “drastic measures...to check the
rapid growth of current and future liabilities and reduce the adverse
consequences of long term growth (of debt) and monetary instability.”
It went on to note that there is currently over US $600 Trillion of global
financial Derivatives Debt...which is 10X annual global GDP.
What Does the Future Hold?
The magnitude of current private and
government debt, coupled with massive unfunded contingent liabilities for
promises of future services to their citizens, is simply impossible for many
nations to fund. Massive inflation in the money supply will become the
preferred vehicle to deflect the default monster, but it will result in
vastly devalued currencies and price inflation as a prelude to default. Their
objective is to buy time to stave off the inevitability of default. Buying
time might also allow the tooth fairy time to arrive with a magic solution.
Standby for a daily diet of social
unrest caused by persons whose comfortable lifestyle and elevated standard of
living is about to disintegrate before their eyes.
Protect yourself with precious
metals investments. Gold and silver in the form of bullion or mining
company shares will give you peace of mind. They
are 'real money' and will be your safe haven during
the very financially troubled and volatile period ahead. Further
complement such investments with other commodities such as base metals, oil
and gas and agricultural grains - all of which are investments
which will shield you from inflation and currency devaluations but
steer clear of fixed interest rate investments.
Arnold Bock
Arnold Bock is a Canadian living abroad retired from a career in
government. He has a substantial
background in partisan politics and public policy development as well as in
project and program management within the public sector.
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