IceCap Asset Management On Europe: "If You Exclude All The Debt, There's No Debt Problem"

Excerpted from Keith Dicker's IceCap Asset Management,

Virtually every country in the world spends more money than they collect in taxes, and no group of countries has done a better job at this than those that formed the Euro-zone.

This collective group has so much debt, that a recent study by the Bank of International Settlements concluded it would take 20 consecutive years of surpluses to simply bring debt loads back to levels previously reached prior to the current crisis.

Considering that this has never happened before, we have little confidence that this type of spending constraint can be accepted and implemented by any of the respective governments.

There is only one way possible for any person, company or government to spend more money than they earn – they must borrow to make up the difference. And as long as the Euro-zone countries are able to borrow, they’ll be able to extend the charade a while longer.

This is the point when many investors and pro-Euro supporters will argue that all of the Euro-zone countries are able to borrow, and in fact each country is able to borrow at the lowest interest rate in history for each individual country.

This is indeed true. However, this is the point when IceCap reminds investors that there are two types of debt markets.

The first is the one where the price or interest rate you pay is determined by the open market, with no interference or influence by other forces.

In 2012, the Euro crisis reached it’s latest crescendo and each country’s ability to borrow was at the mercy of the open market.

Within a span of several months, the cost of borrowing increased from 50% to 100%. In effect, the open market said these bonds are very risky and there’s a pretty good chance, investors will not get their money back.

What happened next was a second type of debt market where prices and interest rates are directly and strongly influenced by governments via their central banks. To prevent the Euro-zone from collapsing in 2012, the ECB (European Central Bank) implicitly guaranteed borrowing for each Euro-zone country.

This second type of market is one where prices are not determined by private investors and a free market. For our economic buffs, this is similar to a centrally planned market or a closed market place. For the average investor, simply think about how products and services were priced in the Soviet Union prior to the collapse of communism.

The Table below demonstrates the key differences between these two types of markets. Anyone who argues that today’s European bond market is a free market and that current prices reflect reality, really shouldn’t be in the investment business.



Some will argue that the continued bailouts and stimulus packages from the ECB will allow the Euro-zone to continue on its merry way into eternity. We believe otherwise. None of these stimulus programs are feeding money down to the unemployed. Many are becoming extremely frustrated, and this is being reflected in the high turnover of current governments, increased popularity of extreme right and left wing parties as well as a rise in popularity of separatists movements.

Every market has a release valve, and for Europe it will be the bond market. The beginning of the end, so to speak, really starts when social unrest reaches a new level. It’s at that point confidence rapidly declines and so too will the European bond market.

Today, those that are comfortable investing in bonds issued by European governments, banks and insurance companies really don’t appreciate how far and hard this market can drop. The entire bond market is really like the Hotel California – getting in was easy, but just don’t try to leave. This is the point when the Euro bulls will discover the true market price for their Euro fixed income bonds.

The breaking of the Euro bond bubble will be much different than the breaking of the Technology bubble. The key reason for the difference is that the bond market is the funding mechanism for banks, insurance companies and governments. Any struggles in this market will absolutely ripple across to the equivalent markets in other countries.

We want to stress that this is a very complicated subject and perhaps this is the reason why it isn’t discussed by other managers, the big box banks and the main stream media.
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2014.09 IceCap Global Market Outlook