The transatlantic panic

Nov 27, 2011·James Turk

In recent months the European sovereign debt crisis has acquired a transatlantic scope. The political posturing in the summer surrounding the debate to increase the US government’s debt limit has highlighted the fragility of its financial position.

That awakening in turn led to the US government losing its triple-A status as well as a greater awareness that numerous US states and local governments have for too long lived beyond their means, a point emphasised by the recent bankruptcy of Jefferson County, Alabama – the largest municipal bankruptcy in US history. And as was made clear this week, politicians in Washington still remain at loggerheads on the issue of cutting the Federal deficit. All of this has contributed to greater financial unease on both sides of the Atlantic.

We need to add to the mix of over-leveraged sovereigns the United Kingdom, which is probably more deserving of a downgrade from triple-A status than the US. More alarming is the fact that the problem of over-leveraged governments is not unique to Europe or North America. The problem is global. Japan has the dubious distinction of ranking among the most leveraged sovereigns. Consider too the Chinese banks, many of which responded to Chinese government policy to fund pet projects and therefore have become over-loaded with an incalculable amount of loans never to be repaid. Following in the footsteps of these larger economies, dozens of smaller countries have also borrowed too much.

Though the scope of the problem that has been plaguing markets and economic activity even before the collapse of Lehman Brothers is global, its core causes are the same regardless where one looks. First, there is too much debt, which is rapidly becoming a reality recognised both by borrowers and lenders. As they reduce their leverage to more prudent levels, economic activity decreases, which leads to the second problem.

Many loans made by banks during the boom years are far beyond the ability of many borrowers to repay. These dubious assets on bank balance sheets are in many cases greater than the bank’s capital, meaning the bank is insolvent. That condition puts at risk the currency its customers have on deposit with it. The fact that there are so many banks that have too little capital to absorb the losses from substandard debt leads to the third problem.

Government policymakers seem unwilling to accept the reality that a financial bust follows an unsustainable boom with the same certainty that night follows day. They apparently believe that they can stop what is shaping up to be a messy train wreck. Don’t believe them.

Their only response has been to throw good money after bad by forcing central banks to buy unpayable sovereign debt that market participants do not want and to ban short selling in different stock markets. What these actions by governments make clear is their inability to put their own financial affairs in order. There exists a pervasive lack of political will to put national monetary and financial systems back onto sound footing.

In today’s environment where the Federal Reserve promised near zero rates for at least two more years and the ECB vowed to buy Italian and Spanish bonds, two things are clear.

The present financial bust is not yet over. Nor is the bull market in gold and silver.

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