Tuesday, March 28, 2017

Investors Hope For 'Correction' Cure - But It Won't Prevent the Ultimate Debt Crash

The Wall Street Journal yesterday featured a front page article, 'Stock Retreat Has Its Fans', which piqued the interest of many.  Quoting from the first two paragraphs:

"Many investors and analysts fear a postelection rally that has driven the S&P 500 up roughly 10 percent has cleaved share prices from the underlying fundamentals that tend to drive gains over time, such as interest rates and corporate earnings.

What's due now, some investors say, is a correction: a 10 % pullback from the indexes' March 1 high. They contend such a retreat would tamp down speculation, defray pockets of froth in popular investments and provide buying opportunities for those still on the sidelines."

The article goes on to state that such declines serve an important function in a market economy basically letting some of the excess 'gas' out of the balloon - which might otherwise blow up, i.e. resulting in a major crash. In this regard, the stock market is already well into bubble territory. Thus, long periods without the healthy corrections lead to market pathology and "unruly trading" - inflating the bubble further until it bursts.

Some may console themselves that a 10 percent correction or maybe even 12 percent, will ease their insecurities but alas, the crash is still on its way. What I would call a "sovereign debt crash" because it will ultimately be the recognition that most national debts can't be repaid that will be the tipping point to one of the largest crashes on record.

First, let's understand the nature of a sovereign debt crisis.,  Sovereign debt is not the same as the mortgage crisis which nearly brought down the global finance system in 2008. The latter was predicated upon the unwise purchase (mainly by banks but also by some insurers like AIG) of esoteric derivatives called “credit default swaps”. These basically represented bets on packaged mortgage securities called collateralized debt obligations.

In the case of the sovereign debt crisis, nations – not banks- are on the verge of default and are seeing their national bond ratings plummet because their debts are too high in relation to their gross domestic product (GDP).  In my March 22 post, I already noted Barbados as being deep in the maw of a sovereign debt crisis.  This followed yet another Moody's bond downgrade, down to Caaa3+, and Barbados now being on the verge of currency devaluation.

The Moody's report on the reasons for the downgrade included:

The government debt burden reached 111% of GDP at end-2016, and the authorities have accumulated a large stock of arrears to the private sector and the National Insurance Scheme,, estimated at a further 11% of GDP at end-FY2015/16. 

The National Insurance scheme is similar to Social Security in the U.S. and what the Moody's report indicates is that this program is over extended with the gov't already in arrears in what it owes (fro borrowing from the NIS) by 11 percent of GDP. In other words, the Barbados government is printing millions of dollars a month to try to keep seniors receiving their pensions.

Some may believe Barbados is an exception, but it isn't. Around the world governments are buried in debt - sovereign debt. It is this debt bomb - building up - that will ultimately roil the markets, along with serious missteps by the Trumpites in handling any future financial crises.  

But back to the sovereign debt crisis, not only is the U.S. in up to its eyeballs, with the Trumpites set to blow the debt wide open, i.e.
No automatic alt text available.

That is, the federal debt as a percentage of GDP would explode through the roof - exceeding the size of the entire U.S. economy within ten years. of Trump and the GOP get their tax policy plans rammed through.

Meanwhile, Europe is printing euros like there's no tomorrow, and debt - especially in nations like Spain, Portugal and Greece, piling up to unprecedented levels.  Then there is the Bank of Japan which has printed over 13.3  trillion yen   The Fed in the U.S. has done its own form of printing money by way of "quantitative easing", purchasing over $4 trillion in the bond market.

All of these signals in tandem show the instability of the global debt crisis and no one who looks into these can remain complacent. Barbados, of course, is near and dear to my heart  - so I pay special attention to what goes on there, like I do here in the U.S. But other nations' debt issues can't be overlooked because they also impact our own financial-economic conditions. As their own sovereign debt crises have manifested the oncoming 'train wreck'  is difficult to avoid. Expect to see default after default.

What's my main worry looking at Barbados and other nations? Well, that none of their debts will ever be repaid. Those debts, including unfunded liabilities into the future (e.g. pensions to be paid) are simply too huge for repayment even in instalment. The credit agencies Standard and Poor's and Moody''s already seem to recognize the writing is on the wall in the case of Barbados, which is why the loan conditions now are so draconian there's no way the debt will be covered.

It is no 'biggie' then to foresee that the debt collapse now drowning Barbados will very soon hit Europe, then spread to Japan - and the U.S. by the end of the year.   That end point will be accompanied by falling oil prices, failure to raise the debt ceiling after a brutal partisan showdown (and Trump -GOP bravado), and then cratering bond prices.

Obviously, borrowing more money for any sovereign debt nation isn't the answer. It hasn't been for Barbados, and has only pushed it into a debt hole. The same is true for Greece, Spain, Portugal, Japan and others.  Borrowing is especially useless as the loan terms are degraded - less money on offer, accompanied by more demanding loan condition. Ask Barbados' Central Bank.

Yes, a correction will likely help in the immediate future to stabilize stocks, but not in the longer term, and Trump's own actions may precipitate whatever crash is in the works to happen much sooner.

No comments: