When Money is No Longer Money

It looks kind of ominous outside. As storm activity engulfs Sydney it seems fitting that the Day of Reckoning could finally be upon us.

Italian bond yields have just hit the point of no return. As you can see from the chart below yields on 10-year Italian bonds closed at 7.25 per cent overnight, after hitting a high of 7.48 per cent.

For an economy with a government debt-to-GDP ratio of 120 per cent and no economic growth in sight, this is a fearsome borrowing cost. Even worse, Italy could well be slipping into recession. Recessions hit government revenues and increase their expenses. In other words, that ratio is set to get worse as GDP contracts and debt grows.


Which is why Italian bond investors are bailing. Italy has the third largest government bond market in the world (behind the US and Japan) at €1.9 trillion. Around €300 billion is due for refinancing in the next year. And if the country does go into recession, it will need to access even more funds to keep its bloated welfare state afloat.

At these rates of interest, it won’t be able to do it. But Italy’s too big to bail. Greece, Portugal, Ireland are all sideshows compared to Italy. The European debt crisis is now moving into uncharted waters.

This is the slow death of the Western welfare state. It’s not about the individuals. It doesn’t matter whether it’s Papandreou in Greece or the lunatic Berlusconi in Italy running the show. Their replacements will have no more idea about what to do to ‘fix’ things. This is about a corrupt and bankrupt system.

It’s a system of socialism masquerading as capitalism. Where the supposed king capitalists – the bankers – are the worst kind of socialists. They expect others to bail them out when things go wrong. And their screwed up philosophy is supported by a coterie of advisers (economists) who have been brainwashed at government-funded universities.

For decades, European governments have been run by a bunch of crooks. To retain their hold on power they have promised their people cradle-to-the-grave care. These promises have been paid for by borrowing money…money created by central banks and commercial banks via the ‘magic’ of fractional reserve banking.

But now the game is up. The politicians, being greedy and stupid creatures, got in too deep without understanding the limitations of the debt-based system they were rigging to their benefit. While the focus is squarely on Europe, it’s only a matter of time before this reality hits Japan and the US.

There are a few things to think about here.

Firstly, money is money until it’s not. What does that mean?

Well, government bonds have for decades been considered risk free. Putting your ‘money’ in government bonds has been socially and financially acceptable. The market has therefore considered government bonds as good as money for years.

Even though they are vastly different things, the market place’s perception is that government bonds were ‘money like’.

No longer. Greek, Portuguese, Irish and now Italian government bonds are not considered to have anything like the qualities of ‘money’. They are high risk.

The implications of this are huge because as the crisis moves into the centre – Spain is next, followed by France, Germany and eventually the US and Japan – government debt all over the world will have lost its risk-free status.

Trillions of dollars of assets (a government’s debt is, unfortunately, someone else’s asset) will no longer be perceived to have money-like qualities. When this perception takes hold, hundreds of billions of dollars of value will disappear.

This is what has just happened to the Italian bond market. That €1.9 trillion pile of debt just lost its perception of being safe and money-like. Now it’s worth a lot less in the accounts of the banks and pension funds that own it. That’s why global markets, led by the financials, tanked overnight.
The key take out here is that such a change in perceptions (which is really the market waking up to itself and catching up with reality) is hugely deflationary.

This is why the European Central Bank (ECB) is under so much pressure to buy up unlimited quantities of Italian debt. But will they? Can they?

The ECB already holds hundreds of billions of euros of peripheral nations’ debt. It’s pretty much insolvent itself. But central banks play by their own rules so that shouldn’t stop it acting as a going concern.

But the ECB is hampered by its flawed and bureaucratic structure from making quick and forceful decisions. In addition, its belief system is German – that is, driven by a fear of hyperinflation. Large-scale debt monetisation will not come easy.

The pressure on the ECB to ‘do something’ will be huge. If it prints, Germany will object and likely leave the Eurozone (they have an inflationary get-out clause). If they don’t the peripheral nations will be forced to leave.

Either way, the Eurozone as we know it is dead. It was inevitable. But you can thank political incompetence for speeding up the process.

How it all plays out from here depends on the ECB. If this thing escalates in the next few days, expect another weekend conference and Sunday night announcement about plans to ‘contain’ the crisis.

Whatever they come up with (again) will be useless. The Day of Reckoning for Europe’s post-WWII socialist experiment just arrived. The judgment isn’t looking too good.

The perception of money is changing very quickly. Italian debt just lost it. The debt of other countries will follow in its path. Soon, the only asset left with its perception of money intact will be gold. And by then it will be worth a lot more.

Make sure a portion of your wealth is stored in the yellow metal.

Greg Canavan,
for Markets and Money

Greg Canavan
Greg Canavan is a contributing Editor of Markets and Money and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails. For more on Greg go here.

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4 Comments on "When Money is No Longer Money"

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Quick question: I know printing leads to inflation, or even hyper inflation, and that punishes savers. But given that the entire western world seems to be in debt, who cares? It would be handy to know when it is coming though, I could clock up a couple of hundred grand worth of credit card and auto debt.


@ geo: Same question here. Although we all know its easy money that got us into this mess, shouldn’t we all rush out and get debt and fix rates?

The welfare state works great, just tax the wealthy properly and the debt will disappear. Close the off shore tax havens, get a grip on the Swiss banks and transfer pricing, cut tax welfare and subsidies to corporations, introduce a financial transactions tax, and introduce democratic accountability into the relationship between business and government. And yes, also let the market rip – let capitalism destroy those banks that lent poorly thinking they would never be held accountable. The first freedom of business is to go broke, and let those investors who sit on their tails and demand the world pay… Read more »

@Nick. Very much agree on tax havens and Transfer Pricing.
I recently read a book that alerts us as to how Australia is getting raped on imported goods.
We pay more that most other countries for identical products, the importers are charged minimal duties, then multinationals use transfer pricing to pay minimal tax in Australia (or even make a loss) while taking most of the profits in tax havens.
The reason that Australian businesses can’t compete. What is the point in free trade if no-one else is playing by the rules?

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