“Euro debt crisis deepens as ‘contagion’ spreads from Greece to Spain,” lead today’s Independent. And now you get the feeling that policy makers only have a couple of bullets left in their gun to prevent a bigger panic in the market. Of course, maybe it just feels that way because of the drumbeat of coverage in the media. But what is the likelihood of the Greek debt crisis becoming a “contagion” across Europe and beyond?
Well the simple matter is that many nations have been living beyond their means and investors are beginning to doubt governments are good credit risks. That’s saying something, when governments can simply confiscate from the public the money needed to pay bond holders. But debt-to-GDP levels are now so high across the Western world that bond investors (and ratings agencies) are having serious doubts.
The credits ratings analysts at Standard and Poor’s have been busy. A day after downgrading Greek and Portuguese debt, the analysts downgraded Spanish debt too. And now words like “viral” and “contagion” are…uh…spreading like…a disease.
“The contagion from a Greek default could also spread to much larger economies where the public finances are also fragile, including the U.K. and, perhaps the biggest risk of all, Japan,”said Julian Jessop, chief international economist at Capital Economics. Jessop somehow left out the U.S, which is astonishing given that the U.S. Treasury Department will auction US$129 billion in new debt this week. Yields on 2-year, 10-year and 30-year U.S. debt all rose (and prices fell).
But now the metaphors get complicated. You’re going to start hearing a lot of commentators say that this is a crisis of confidence. But when is the last time you stopped a cold with a strong sense of self belief?
To say the sovereign debt crisis is just a crisis of confidence is to ignore Europe’s (and Japan’s, and the U.K.’s, and America’s) failing fiscal welfare state model. This model is not surviving its first contact with the inevitable math of demography, where you have more pensioners and rising health care costs and fewer tax receipts.
That’s why it’s not a question of confidence. It’s a question of debt default. Who’s going to go first?
The alternative being contemplated is a kind of firebreak engineered by the IMF and the European Central Bank. These organisations would draw “a line in the sand” and provide a large line of credit or loan guarantees to all the troubled nations of Europe. And how much would THAT cost?
According to the good people at Goldman Sachs and JP Morgan, about €600, or A$857 billion. That seems like a lot of money. And that seems like a big gamble. You try and restore confidence by putting a trillion dollars on the table and saying, “Look at THAT!”
But that looks more like bravado than real self-confidence. So it looks like we’ll see how durable the common currency project is. And in the meantime, that ought to mean more U.S. dollar and gold strength. In fact, with so many governments in so many places printing so much money, it shouldn’t surprise you to see a whole basket of commodities benefit…for now.
However this just pushes out into time and amplifies in size the next phase of the crisis. It’s all, at heart, a debt crisis. And before it’s over we reckon there will be both collapsing asset values AND hyperinflation. But we’ve been over that ground before so we won’t rehash it here.
And as bad as the problems in Europe and America and Japan could get, the biggest threat to Australia – by far – is the deflation of China’s credit bubble. It’s the proverbial elephant in the room. It’s the one most important assumption about Australia’s fiscal and economic forecasts that is not seriously examined or rigorously questioned…mostly because what might result if China runs off the rails is too scary to think about.
But it IS worth thinking about. And planning for. Because whether you like it or not, it is coming anyway. China’s story is inextricably linked with the great credit bubble of the last twenty years. Investment has given way to speculation and credit growth has fuelled a construction boom, all of which has been very good for Australian resource stocks. But for how much longer?
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