We have officially entered Round Two of the Financial Crisis.
Round One took place from 2007-2008, consisting largely of private debt (derivatives, credit default swaps, etc) taking down private companies (banks, financials, insurance companies), etc. The US Government response to this was to nationalize various entities (mortgages, insurance, etc) and to shift this debt onto the public’s balance sheet.
The Fed and other Central Bankers like to dress these moves up in fancy language and financial terms, but in reality they all boil down to one of three strategies:
1) Printing money/ pumping it into bankrupt financial entities.
2) Shifting garbage assets from the private sector onto the public sector’s balance sheet.
3) Creating more debt
In plain terms, the world’s Central Bankers, particularly the US Federal Reserve, bet the farm that their countries could swallow trillions in garbage assets without bond investors catching on and demanding higher yields (interest rates).
Debt Defaults for the Holidays
Remember, the world was already awash with debt BEFORE the Crisis began. Indeed, excessive debt was what caused ROUND ONE of the Crisis. For decades, world economies, most notably the developed ones (Japan, the UK, Europe, and the US) were spending beyond their means via various social entitlement programs.
Central bankers opted to try and fix these debt problems by… issuing MORE debt.
It’s total insanity, but it worked temporarily because investors had not yet caught on that Round One of the Crisis was a “game changer.” Remember, the monetary interventions, bailouts, and stimulus plans implemented between 2007-2009 were unprecedented. In just three years we spent more money than WWI, WWII, and the New Deal combined. So it’s no surprise that it took a couple years for the “dumb money” to catch on.
Which they did with a vengeance in late 2009.
Every debt transaction involves two parties: a lender and a borrower. The latter can only go into debt if the former is willing to lend to him/ her. However, if the borrower keeps borrowing, at some point it becomes clear to the lender that he/she is never going to get his/ her money back. When this happens, lenders:
1) Lend for a much shorter time period (hopefully insuring that they get their money back before the inevitable bust).
2) Demand higher interest on the loan to compensate for the risk.
3) Stop lending to the borrower.
Lenders did all three of these to financial entities during Round One of the Financial Crisis (2007-2008). As stated previously, the Government response to this was to shift the private sector debt that was scaring lenders away onto the public’s balance sheet.
Please note, they DID NOT pay off the debt or let the entities default (solutions that would have SOLVED the problem), they simply moved the debt from one place to another.
Because of this, the structural issues plaguing the world’s financial markets (balance sheets/ solvency) were not fixed. Consequently, lenders’ confidence was not restored. Consequently, lenders have begun questioning/ re-assessing ALL debt worldwide.
Small wonder then that countries with weaker global economies (those whose economic activities were largely based on tourism, real estate, financial speculation, etc) soon began to suffer from a lack of investor confidence.
Indeed, Round Two of the Crisis, the Sovereign Debt Round, began over Thanksgiving of 2009 when Dubai had a “virtual default,” asking for a six-month extension on $60 billion worth of its debt.
The issue then spread to Greece over Christmas 2009. It will not end there. As is know known, Greece’s debt levels are anything but unique. Indeed, Ireland, Spain, and the UK all are running comparable deficits. Italy actually has a higher Debt-to-GDP ratio. And Germany and the UK are only a couple of years off from having Greek-level Debt-to-GDP ratios themselves.
Eventually, these issues will hit the US’s shores. Indeed, if Greece’s numbers are “Crisis Worthy” investors should consider that the US’s fiscal condition is in fact AS BAD IF NOT WORSE than Greece’s.
The US is expected to run a $1.7 trillion deficit in 2011. Assuming that the GDP numbers are accurate (they’re not, but that’s an article for another time), the US economy is in the ballpark of $14 trillion. This means we’re running a deficit equal to 12.3% of GDP. That’s RIGHT next to Greece.
Then of course, you’ve got our Debt-to-GDP ratio. If you ignore unfunded liabilities like Social Security and Medicare, the US already has a Debt-to-GDP ratio of 98.1%. That’s only slightly off of Greece’s Debt-to-GDP of 112%.
Throw in Fannie and Freddie’s mortgage debts (Uncle Sam own $5 trillion of these now too), and we’re already well over a Debt to GDP of 112% (actually it’s 130% or so). And when you include Social Security and Medicare ($45 trillion) this puts total US Debt-to-GDP at 421% ($59 trillion of Debt on a GDP of $14 trillion).
In plain terms, the very same issues that took down Greece and much of Europe exist in the US. Which is why, if you haven’t already taken steps to prepare for the coming Crisis, you need to do so NOW.
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