Now That Greece Has Defaulted, the Default Dominos Are Coming Fast

Now that Greece has defaulted (and it was a default) I believe that in the coming weeks we will see other PIIGS countries line up for defaults. Indeed, we are already seeing hints of this:


Portugal, Spain urge G20 members to help ease crisis


Spain and Portugal said on Saturday the euro zone's debt crisis is a global problem, calling on the United States and other G20 powers to help contain the fallout.


Spanish Prime Minister Jose Luis Rodriguez Zapatero urged the G20 countries least affected by the crisis to provide "urgent stimulus plans" to shield the global economy.


Europe's debt crisis looks set to dominate the summit of Group of 20 leading economies in France from Nov. 3-4.


Merkel: Must prevent others from seeking hair cuts


Chancellor Angela Merkel said on Friday it was important to prevent others from seeking debt reductions after European Union leaders struck a deal with private banks to accept a nominal 50 percent cut on their Greek government debt holdings.


Now that a precedent has been set for debt defaults, other nations will soon follow Greece into debt restructuring. This is where things will begin to get really interesting for the EU.


While Greece is already presenting serious problems for the European Union, it is Italy that will prove to ultimately break the Euro’s back.


Italy’s GDP is $2.05 trillion, making it the third largest economy in the EU and the EU’s biggest financial headache. It has the second worst Debt to GDP ratio in Europe (behind Greece) and the third largest bond market in the world (behind Japan and the US).


In plain terms, Italy is a HUGE problem for the financial system. And it’s only going to be getting worse. Indeed, Italy’s reality is already far worse than most realize today.


When you throw in unfunded liabilities, Italy’s REAL Debt to GDP ratio is north of 360%.  In order for Italy to meet ALL future liabilities, it would need to have an amount equal to nearly 10% of its GDP sitting in a bank collecting interest FOREVER.


Suffice to say, Italy doesn’t have that cash. And based on its debt maturation cycle I expect we’ll see an Italian default within the next six months. Indeed, no matter what happens with Greece, Italy will make sure that the EU in its current form no longer exists within the next year.


In the next 14 months alone, Italy needs to roll over an amount of debt equal to over 30% of its GDP ($615 billion). When you add in NEW debt issuance to meet Italy’s deficit, the number balloons up to 40% of GDP or $820 billion.


The problem with this is that investors are quickly waking up to the fact that Italy is BROKE. With a GDP growth rate of 1.3% and an aging population, Italy’s economy is in shambles.


In this environment, appetite for Italian bonds is collapsing, resulting in higher interest rates on Italian bonds, making Italy’s debt payments even larger (each new percentage point in interest rates means $4.1 billion more in funding costs for Italy in 2012).


            Italy at heart of crisis as borrowing costs climb


Italy's borrowing costs jumped to record levels Friday, underlining its vulnerability at the heart of the euro zone debt crisis and skepticism about whether the struggling government of Prime Minister Silvio Berlusconi can deliver vital reforms.


The 6.06 percent yield paid at an auction of 10-year bonds was the highest since the launch of the euro, and not far from the level reached before the European Central Bank intervened in August to cap Rome's borrowing costs by buying Italian debt.


Indeed, by many accounts, the only reason Italy hasn’t already staged a failed bond auction is because the ECB has been aggressively intervening and buying Italian bonds.


In plain terms, if it were up to the market alone, Italy would have already defaulted. And yet… Italy is somehow going to find investors to buy up $800+ billion worth of its debt?


So Italy will be defaulting. And it will be defaulting sooner rather than later. The question all investors must ask themselves is: what happens when Italy defaults?


Global exposure to Italian debt is north of $860 billion. This is over THREE TIMES the exposure banks have to Greece… and we’ve already seen the impact that situation has had on the markets.


Regarding exposure to Italian bonds, European banks comprise 90% or $782 billion. As Bank of America Merrill Lynch notes, foreign bank claims on Italy are higher than for any of the other PIIGS countries.


The significance of this cannot be overstated. Indeed, it was $3.2 billion in Italian bond exposure that took down MF Global.


More and more, it looks like the EU will be broken up in the coming weeks. When it is this market rally will collapse. And the ensuing carnage will make 2008 look like a joke.


So if you have not already taken steps to prepare for systemic failure, you NEED to do so NOW. We're literally at most a few months, and very likely just a few weeks from Europe's banks imploding.

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Good Investing!


Graham Summers