Friday, August 3, 2012

Next Up In Sovereign Debt Crisis: Japan Or The UK?


As I discussed earlier in the week in the $15 Trillion Adjustable Rate Loan, I think we are in the second or third inning of the global sovereign debt crisis. While the current action has been well documented and can be seen in every in almost every news story today (the rolling collapse of the European Union), I always like to think about what is coming next.
It has been my view since the sovereign debt crisis erupted that the next battles will be fought in Japan and the UK. The key questions of course are who will go first and how will these battles look compared to the current European debt crisis?

The answer to the first question can only be guessed. It is like having two neighbors that are underwater on their home and are currently not paying their mortgage. Which one will enter foreclosure first? The answer is impossible because it depends on the judgement of a third party; the banks holding the mortgage.

The same goes for two bankrupt countries such as the UK and Japan. Which one will implode first? The answer again depends on a third party: the bond market.

I remember having this discussion back in the summer and fall of 2010 with Spain and Italy. The nerds like me on the blogosphere were having an intense debate over which country would erupt first. Both countries were primed for implosion but their problems were very different in nature.

Italy had a horrendous government debt to GDP ratio (closing in on 130% looking out into 2011 at the time) while Spain had a much more mild debt to GDP ratio (standing below 70% debt to GDP at the time). However, Spain as everyone now knows today had a massively underwater banking system, a housing bubble collapsing, and local government debt issues that added to the total problem beyond just the implicit government debt in place. They also had a tougher bond/rollover schedule in 2011.

The consensus view was that Spain would go first. Then, in the summer of 2011, Italy shocked the financial nerds (the mainstream media was oblivious to any problems coming) and became the center story line with their bond yields rising rapidly. They were now "next" in the sovereign debt crisis. Italy was equally as bankrupt as Spain, but the bond market decided to move on them first.

That Spain or Italy could possibly be in trouble was of course "shocking" to the mainstream press who continued to follow the story lines in a reactionary manner and assumed that every new bailout announced was the answer to the underlying problem.

Then, after the fall, Italy moved out of the spotlight and Spain emerged as the main headline. They have stayed there since, becoming the new darling of the global sovereign debt collapse.

Now the nerds like me are having the same conversation we were back in 2010 with Japan and the UK. Ironically, they face similar comparisons as Spain and Italy in terms of their debt problem structure (the size of course is much large - the equivalent to two enormous meteors approaching the financial system).

Japan, like Italy, has a horrendous debt to GDP ratio. They actually have the worst debt to GDP ratio in the world, which will cross over 230% this year. That is not a typo. The UK, like Spain, has the worst debt to GDP ratio in the world when you take the sum of all their liabilities: (non-financial, financial, governments, households) a number now approaching 1,000% of GDP. That again is not a typo, although the numbers almost make you laugh when you think about it.


So which one will go first? I have no idea, but my money is on Japan. Because of this I have laid out an exhaustive study of their problems numerous times in the past (see below for links).

The truth is it doesn't really matter. If you know both of your neighbors cannot pay their mortgage, would you go to the bank and ask to invest some money into the debt? No, you would stay away from both pieces of debt and put your money somewhere else. This is common sense when looking at an example in the real world yet interest rates on Japanese and UK debt today stand at close to record low levels.

The second question is how will this phase of the debt crisis differ from what we are experiencing now in Europe? The answer to that can be summed up very simply: The European Central Bank (ECB) is restricted on its ability to purchase government bonds with printed money. This impairs their ability to fight off bond vigilantes as they attack the debt of the PIGS countries. Just yesterday Spanish and Italian yields rose by the most ever on a single day after the ECB announced they had no new "printing" programs in place.

The UK and Japan face no such restrictions. Their central banks have unlimited firepower to purchase, well, everything. This is already taking place now as a pre-emptive strike (warning?) against anyone who dares to challenge their bankrupt government bond markets. The following is a chart showing the Bank of England's recent balance sheet growth (a balance sheet grows when the central bank prints money to buy assets and adds those assets to their balance sheet).


The Bank of Japan is already fighting the same battle. Their central bank, along with a steady purchase of government debt, has also entered the stock market to purchase assets.

The truth is that the United States is in the same exact position as Japan and the UK but most people believe that they will be the last and final act of the debt crisis. Could they surprise the world and jump ahead into the headlines? Of course they could.

Investors today are fleeing Europe and running into the bonds and currencies of Japan, the UK, and the United States. They have moved from one bankrupt entity into another. They hope to be able to exit the burning theater when the fire starts (into the next currency choice) before the rest of the crowd.

But why would they take that chance? There are sovereign bonds in countries like Canada, Australia, New Zealand, Hong Kong, Singapore, China, and Brazil where the countries are not bankrupt. They have real economies and exports. They do not need a printing press in order to survive into the next year.

In the currency wars the ultimate winner will be gold and silver but most investors do not feel comfortable keeping 100% of their portfolio in precious metals (and they shouldn't). Short term debt of stable governments with strong currencies seems like a logical addition over a bankrupt country.

But that is just me. I usually choose not to go to the movies in a theater I know will catch on fire.

For a comprehensive review of the coming Japanese debt crisis see: Japan Government Bonds: The Storm Cloud Approaches.

h/t Sober Look

Robert Shiller: New Bubbles Forming In US Housing Markets

Robert Shiller, the co-producer of the Case-Shiller home price index and author of the masterpiece "Irrational Exuberance" released at the peak of the stock market bubble in 2000 (and then re-released to focus on housing at the peak of the housing bubble in 2005), discusses the possibility of new housing bubbles forming in markets such as Phoenix and San Francisco. He feels this is due to the the artificial lending standards created by the Fed and the government. For more on this topic see Case-Shiller: US Home Prices Rising.



Wednesday, August 1, 2012

The $15 Trillion Adjustable Rate Loan: Who Will Bailout Governments?

The total government debt around the world has now crossed $45 trillion. That is $45 trillion that governments have borrowed and promised that the tax payers within their countries will pay in the future.

The top ten largest debt countries around the world owe $30 trillion of this debt. What would create a problem with this situation?

Remember during the housing bubble when people used the term "adjustable" rate mortgage. Homeowners were not seen as being in trouble with their initial "teaser" rates during the first 1 - 3 years of the loan, it was when the loan became adjustable (and would adjust significantly higher) that some people began to worry.

The governments around the world have financed their debt through the same exact process. Over the next 3 years, through 2015, the top ten government debtors will have to roll over (refinance) 50% of their entire debt burden: $15 trillion dollars.


The entire housing market was $16 trillion in size back in 2006 and only a fraction of that amount was adjustable rate subprime loans (close to 50% of homes were owned free and clear and a large percentage actually borrowed what they could afford and took out 30 year fixed rate mortgages).

So if a small fraction of $16 trillion running into trouble took down the entire financial system, what will occur when an entire $15 trillion sum will need to be refinanced?

People's natural reaction is to say that "governments will bail them out." But wait a minute, it is the government debt that is about to implode. Greece, Spain, Ireland, Portugal, and Italy cannot go to their government for a bailout.

The answer is that it will come from the central banks. We are only in inning 2 or 3 of the sovereign debt crisis and it will pick up in size and magnitude as we move forward through Japan, the UK, and the United States.

The following shows the growth in size of the central bank balance sheets for the "Big 4" central banks since 2006:

The Federal Reserve (United States)
The European Central Bank (Europe)
The Bank of England (The UK)
The Bank of Japan (Japan)


Growth of their balance sheets means that central banks are printing money to purchase assets (which are then added to their balance sheets).

All eyes are on the Federal Reserve and the European Central Bank (ECB) over the next 48 hours to see what their announcements will be. The truth is that easing is going to come continuously from every major central bank around the world during the next three years. There is no other source of money available to refinance $15 trillion in sovereign debt, which does not even include new additional debt (borrowed through deficit spending) during 2012 - 2015 that will be incurred as these economies slow down. The US alone will add at least $3 trillion in new debt issuance during 2012 - 2015 and most likely much more.

On top of the $45 trillion in global government debt there is an additional $135 trillion in consumer, business, state and local, and bank debt. The world is drowning in debt and as the global economy continues to slow down, triggered from the European Union sovereign debt meltdown, it makes it more and more difficult to service the burden already in place; never mind even think about how the current global income will finance more.

While the chart above shows the global money supply exploding, the next chart shows annual world production of gold. It has fallen and moved sideways since 2000.


How will the largest period of central bank balance sheet growth (supply of money) over the next 3 years to finance sovereign debt needs combined with a stagnant supply of new gold impact the price of gold?

I will leave that up to your imagination. Keep the big picture in mind and do not be discouraged by short term price movements in the precious metals. If the paper price falls in the short term it only provides an opportunity to add a greater amount of physical metal. You will be very happy with the result by 2015.

For a look specifically at the United States bond market see Long Term Government Bonds: The Largest Bubble & Mania In History.

h/t The PFS Group, The Tudor Group

The Fall Of The American Empire: A Social Divide

The past month, due to the severe droughts impacting crop production, the price of corn and wheat launched  20% higher. While this has a minimal impact on the upper end of the middle class (and helps the rich because they probably benefit from higher prices in their portfolio), it has a major impacting on the poor both in America and around the world.

The divide between the haves and the have-nots continues to widen every year in America, which is the most dominant country in history in terms of both military and economy size since the Roman Empire.

Those that have taken the time to study history know that the fall of the Roman Empire was due to the separation of wealth classes within the country as well as a form of government debt monetization (the original form of QE) to pay for the increased and unnecessary size of their military.

The Roman Empire was not over taken by some larger force. It lost its dominance due to arrogance and a separation within a society that essentially ate itself from within as a larger and larger portion of the population could not survive and turned to revolt to deal with their suffering.

This is all coming to the United States empire, which today is still considered the standard of global dominance specifically due to the demand for its government paper. While I spend a tremendous amount of time here explaining why that dynamic will come to an end, the following video discusses the second portion of what will bring down the empire: the separation from within the society. In a paper money system, which began in 1971, this is the only possible outcome and it is only a matter of when. This decade will usher in the final act.

 

Tuesday, July 31, 2012

Thinking About Olympic Gold Medals

With the Olympics on every television this week you would think I would be concerned with the number of medals my home country of USA has taken home so far this year. Not a chance. I spend my time gazing at the actual "metals" wondering how much the precious coins are worth that hang around the winner's necks.

It turns out that an Olympic gold metal is actual composed of 93% silver, 6% copper, and only 1% gold.

Bummer for the competitors right? Yes, well it is today if they were to take it to a coin shop to sell. However, a market historian might let an Olympic gold medalist know that there is over 2 billion ounces of available gold on the planet. How much available silver is there? Only 1 billion ounces, or 50% less.

That means based on pure supply silver should be worth 2x the value of gold. Will it get there at some point during the mania phase of the precious metals bull market run? That may be a stretch, but you can comfortably say that silver is extremely undervalued today.

Bloomberg discusses:

Case-Shiller: US Home Prices Rising

The Case-Shiller home price index released this morning showed that home prices in the largest 10 and 20 city composites rose 2.2% month over month into May. This was a widely expected rise in prices.


I have discussed in detail recently how home prices will continue to show an artificial bump in prices over the next 6 to 12 months due to two main factors:

1. Interest rates and lending standards being held artificially low and loose due to government financing and the coming anticipation of additional mortgages purchased by the Fed

2. Shadow inventory continuing to be held off the market creating an artificial shortage of inventory 

Unfortunately, buyers of homes cannot "trade" the investment like a stock or bond and sell with the stroke of a computer key. They must put the home on the market and pay a realtor 6% for the service of selling a home. If you think you can make your purchase and get out before interest rates rise and shadow inventory hits the markets then I would go for it. I personally prefer not to play on train tracks.

For much more on these this topic please see:

US Housing: Visible, Shadow, & Ghost Supply

US Real Estate: Where Is The Inventory?

h/t Calculated Risk