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Catching a Falling Financial Knife

Debt Crisis New Phase Striking Now! Despite Bailouts!

Interest-Rates / Global Debt Crisis Nov 29, 2010 - 10:44 AM GMT

By: Martin_D_Weiss

Interest-Rates

Diamond Rated - Best Financial Markets Analysis ArticleSadly, though, even while most Americans were enjoying the holiday or hitting the malls, much of Europe was sinking deeper into a new, more severe phase of its sovereign debt crisis.

This crisis is unfolding despite Herculean rescues by the European Union, the International Monetary Fund and the U.S. Federal Reserve.


It’s striking right now.

And it’s threatening to spread to all of the world’s big debtor nations, including the biggest of all — the United States.

Hard Evidence from Global Markets

This conclusion is not merely my analysis or forecast.

It’s the collective opinion of global investors who, at this very moment, are scrambling to buy insurance against bond defaults by major governments.

Think of it like life insurance:

  • When the premiums are cheap, it’s because the country has a clean bill of health.
  • When the premiums start rising, it means there’s growing evidence of fiscal disease.
  • And when premiums skyrocket to obscenely high levels, you can be darn certain the country’s Treasury is on its death bed, threatening to take down the government … sabotage its economy … and, inevitably, impoverish its people.

That’s precisely the situation the Irish find themselves in today. Their economy is sinking fast. Their two largest banks — the equivalent of our Bank of America and Citigroup — have just gone under. The Prime Minister is resigning. Millions of citizens are sinking into poverty. And yesterday’s final agreement on a $113 billion European rescue package will not change that reality.

Moreover, their crisis is a stark warning for all U.S. investors. So you’d better understand exactly what’s happening and why …

The Real Trauma of The Irish Debt Crisis

Default insurance is the telltale indicator.

And right now, the cost of insuring €10 million of 5-year Irish government bonds against default has skyrocketed — to an extremely high €600,000.

That’s 55 percent more than it cost for the same insurance in the aftermath of the Lehman Brothers failure — a time when it seemed the entire world was on the brink of collapse.

It’s 50 percent more than the cost of insuring equivalent Greek debt at the peak of Greece’s first round of financial difficulties earlier this year.

It’s at least DOUBLE the cost of insuring the debts of deeply troubled lesser nations like Romania, Lebanon, Latvia, and even Iceland.

Most shocking of all, today’s €600,000 price tag for Irish default insurance is higher than it was BEFORE the European Union and IMF first announced their intent to engineer a $113 billion rescue for Ireland just eight days ago.

Earlier this year, when Europe announced a similar bailout for Greece, traders in this kind of insurance — credit default swaps — gave Greece at least a 30-day reprieve. Now, they’ve given Ireland no more than three days.

Investors obviously don’t believe promises by politicians anymore.

Clearly, the Debt Crisis Is Accelerating. Clearly, the Bailouts Are Not Working!

The European authorities had hoped that, as soon as their massive, supposedly “definitive” Irish bailout package was announced, investors would jump for joy. Instead, investors have done precisely the opposite.

The authorities had hoped that the premiums on government bond default insurance would come down dramatically. Instead, the premiums have gone higher, as I’ve just shown you.

The authorities had hoped that Irish bond yields would come down sharply, helping to avert a disastrous, additional interest burden for the government. Instead, bond investors have dumped Irish bonds with both hands, driving their prices down and yields up.

Exactly seven days ago, on the morning after the big bailout announcement, the yield on Ireland’s benchmark 10-year government bond was near 8 percent. Now, it has surged by more than a full percentage point to 9.17 percent. That extra interest cost alone threatens to eat up a big chunk of the bailout money.

The authorities had hoped — and prayed — that their earlier bailout of Greece would have been enough to contain the cancer. Instead, it has metastasized and spread — not only to Ireland, but also to Spain and Portugal.

Right now, the cost of insuring against a default on Spanish and Portuguese bonds is at new, all-time highs, far surpassing the levels reached earlier this year when the Greek debt crisis was first exploding.

Even Greece itself, which the authorities thought was largely cured, is back in the emergency room.

But this time, all life support systems are in serious doubt. And this time, investors are in open rebellion against the spin doctors.

The facts: At the height of the last Greek debt crisis — on February 8, 2010, to be exact — the cost of insuring a €10 million 5-year Greek government bond reached a peak of €420,855.

But last week, the cost on the exact same instrument had surged above €1,000,000!

That’s like shelling out an outrageous $50,000 for a term life insurance policy that pays no more than $500,000 in death benefits.

Why so expensive? Because investors now realize that austerity, no matter how necessary, can never be a quick ticket to fiscal balance.

In fact, the more the Greek government has cut spending, the more its economy has sunk. Ditto for Ireland and other countries.

Urgent Lessons for All U.S. Investors

Even if you’ve never invested a penny in Europe — and even if you’ve never set foot outside the United States — this new phase of the debt crisis has far-reaching implications and lessons for you and your family …

Lesson #1 America Is Definitely NOT Immune to the Contagion

For 2011, the Bank for International Settlements estimates that Portugal’s and Spain’s government debts will be 99 percent and 78 percent of GDP, respectively.

But for the same year, U.S. government debts will be 91 percent of GDP.

Thus, by this measure, America’s debt burden is similar to

Portugal’s and bigger than Spain’s — two countries that are ALREADY victims of the sovereign debt crisis.

Yes, the U.S. dollar is the world’s reserve currency.

And, yes, that gives Washington the ability to print money with impunity … press other rich countries to accept its debts … and borrow huge amounts abroad to finance its deficits.

But that’s more of a curse than a blessing!

It means that, more so than any other major nation on the planet, the U.S. government is beholden to investors overseas — often the same investors who have repeatedly attacked Greece and Ireland this year.

Ultimately, that could make the U.S. even more vulnerable than Europe.

Lesson #2 Governments CANNOT End a Debt Crisis by Piling on Still MORE Debt Europe tried by announcing a Greek bailout earlier this year … and it failed miserably.

Europe tried again by expanding the Greek bailout to a $1 trillion fund for all euro-zone countries. But that effort is also failing. In fact, just one more bailout — for Spain — could wipe out the fund.

And now, even before Europe has figured out precisely how the bailout fund is to be used, there was new talk in high circles this weekend of expanding it even further — another desperate attempt to “reassure investors.”

But again, it is not working.

In fact, the more money Europe throws at the crisis, the more investors seem to recoil in horror.

Investors can now see, as plain as day, how past rescues have backfired.

They can see how the debt disasters can’t be papered over with bailouts or printed money.

And they KNOW that money printing can only gut the currency they’re investing in — be it the dollar or the euro!

In either case — bailout or no bailout — bond investors want out.

Lesson #3 Before a Government Debt Crisis Can Be Ended, It Must FIRST Get a Lot WORSE!

In order to slash deficits …

  • Governments must impose austerity — deep cutbacks in spending, tax hikes, or both …
  • The austerity inevitably drives the economy into a tailspin, and …
  • The economic tailspin always causes even LARGER deficits!

It’s only after years of fiscal discipline and collective belt-tightening that this vicious cycle is ended and balance is restored.

That’s why the cutbacks in Greece, Ireland, Portugal, and Spain are, in the near term, making the crisis even worse. And it’s also why a similar vicious cycle is now looming in the U.S., as the new Congress seeks to slash the deficit.

Lesson #4 The Great Debt Crisis Of 2008 Never Ended!

Politicians talk about the U.S. debt crisis of 2008 … the Detroit bankruptcy crisis of 2009 … the European sovereign debt crisis of early 2010 … the Greek debt tragedy … the Irish debt mess … the California budget debacle … the U.S. municipal bond collapse … and more.

Then, they talk about the urgent need to make a show of resolve to bail out the world — to stop the “contagion” from spreading from one sector or region to the next.

But these are not separate, isolated disasters. Nor is the contagion of fear the true source of the problem.

Instead, what we are experiencing is one, single, integral debt crisis that never ended.

It is one crisis that has spread from the U.S. to Europe and beyond … morphed from a private-sector banking crisis to a public-sector government debt crisis … grown in scope and power … and begun to drive the large debtor nations on a collision course beyond anyone’s control.

Lesson #5 The New Phase of the Debt Crisis Can Bring Surging Interest Rates

I showed you how the yields on Ireland’s 10-year notes have surged from 8 to 9.17 percent in just a few days. Yields in other European nations have shot up as well.

Meanwhile, I assume you’ve seen how, despite the Fed’s massive bond purchases, U.S. Treasury yields have also moved higher.

And you’ve seen even bigger jumps in U.S. municipal bond yields.

This is just the beginning.

And for the near future at least, rising interest rates could be a game-changer — for real estate, for the U.S. economy, and for many financial markets.

Investors aren’t dumb. When they see a new phase of the debt crisis, they rush from risk to safety.

So don’t be surprised if we get deeper corrections in those markets that rose in recent months — U.S. stocks, precious metals, key commodities, and several foreign currencies.

There will always be exceptions. But my recommendation is the same as last week’s: Take profits off the table. Build cash. Focus on safety.

Good luck and God bless!

Martin

This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.


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Catching a Falling Financial Knife