Saturday, February 7, 2009
Thoughts on Default
This is a hundred billion mark note from Germany circa 1923. With this bill you could buy 2 beers during the episode of German hyperinflation which ended in November 1923 when the government finally capitulated and issued the new and improved Rentenmark. You could exchange 10 of these bills to obtain one Rentenmark or 1 trillion old marks to 1! Could hyperinflation happen here? The short answer of course is that it probably could happen almost anywhere. Countries default in different ways. Kenneth Rogoff and Carmen Reinhart are one of the most prolific economic writers and you will see them cited in many searches on economics. They wrote a fascinating study for the IMF and the NBER(National bureau of economic research) where they searched the last 800 years for government defaults:http://www.nber.org/papers/w13882.
They concluded that national defaults were hardly rare. They even used the phrase that these bankruptsies were a "universal phenomenon." France went bankrupt 8 times from 1500 to 1800 and it wasn't always a pretty phenomenon. The regents after the Revolution expropriated chuch property and lands of the wealthy and you bankers take note: they executed many lenders. Spain went bankrupt 7 times in the 19th century alone!
It would seem likely that we will see some national bankruptcies in the near term. The obvious candidates are Zimbabwe and Iceland. The 3 largest banks in Iceland have defaulted on their debt of over $120 Billion which has left every man woman and child in the icy country owing over $500,000! The bank debt to GDP is an astronomical 1000%. Much of the rest of Europe is in terrible shape with the UK, Ireland, Spain, Italy and Greece suffering the most. There are many requirements to join the EU, one of which is a deficit to GDP not exceeding 3%. The EU central bank estimates that the average debt of all members could rise above 4% in 2009 with 17 EU states above 3%. By comparison, the US looks to be above 10% which leaves us out from consideration I suppose. This could pose grave dangers to the EU if some of its members default and according to Der Spiegel, if several countries default, the Euro could collapse. The countries are funding these deficits with bonds which are in the case of Italy and Greece becoming a hard sell without ever escalating interest rates, Most of the European banks including the economic heavyweights like Germany and Switzerland have banks full of poisoned US toxic debt as well as loans to emerging markets in Eastern Europe which are turning sour fast. The UK is in terrible shape with plummeting oil exports from the North Sea and almost total collapse of their financial services industry and their real estate market. The pound is off 40% in the past 6 months and is approaching parity with the Euro. The Brown administration has been pouring money into their banks with the same terrible results there as here and their most recent idea this week is an insurance plan for the toxic debt also eerily similar to the ideas floated by Geithner and his blockheads in Washington. It all hearkens back to Tom Lehrer's song"We will all go together when we go, Every Hottentot and every Eskimo..." The major difference in the US is that we depend upon other countries, chiefly China and Japan, to buy our debt from their historically large current account surpluses. But those surpluses look to be dropping fast. In Japan the Yen has become the strongest currency in the world just as their exports have literally fallen off a cliff . MSNMoney reports that Japan's industrial production is now falling at at a jaw dropping 63% annual rate followed by Korea at 43%. China is keeping a brave face on and figures are hard to come by lately but it appears now that their job losses in the last 6 months are now over 23 Million! It would seem to this observer that if the surpluses go, so will the need to buy treasuries. The surpluses are dropping in the oil exporting countries as well posing obvious potential problems for the treasury auction market. The problems in Japan are particularly acute with a soaring yen and exports so vitally important to their economy. They also have a huge public debt to GDP ratio of 170% surpassed only by Zimbabwe and Lebanon. With a limited understanding of World financial markets, I find it difficult to see who faces the greatest risks other than a few outlier train crash states. Most of us are broke but some are more broke than others. I am preparing a blog on the Japan at the moment which has gone through its own depression in the 1990's and it appears the Japanese government utilized many of the same actions being done by the current geniuses in the BushObama administration.