The Story of the Decade: Sovereign Debt

As I said a few months ago, the story of the coming decade will be sovereign debt.

The Swiss-based Bank of International Settlements (BIS), the oldest international financial institution in the world, has issued a working paper written by three senior staff economists (“The future of public debt: prospects and implications”). In that paper the BIS warns that Greece isn’t the only Western economy that is setting off alarm bells.

The BIS names 11 more economies of concern: Austria, France, Germany, Ireland, Italy, Japan, the Netherlands, Portugal, Spain, Britain – and the United States.

Without “drastic measures,” BIS says, all of these countries will hit a wall of debt.

When the senior economists at BIS warn 12 of the richest countries on Earth that they must take drastic action to reduce debt, you know the situation is bad.

The BIS paper notes that the public debt of 30 OECD countries will (on average) exceed 100% of GDP within the next year, “something that has never happened before in peacetime.”

But that isn't half of the concern. The BIS goes on to warn that conventional debt-to-GDP ratios are misleading – missing “enormous future costs” that are already authorized by past fiscal commitments, that will inexorably inflate public debt further still.

By the end of 2011, the BIS economists calculate, U.S. government debt will have risen from 62% of GDP in 2007, not quite three years ago, to 100%. Britain’s debt will have risen from 47% of GDP to 94%. Italy’s debt will have risen from 112% of GDP to 130%. All together, the public debt of the 12 countries will have risen from 73% of combined GDP to 105%.

At this debt level, the risk of sovereign default rises rapidly. And the BIS analysis says this unprecedented debt level will itself increase “precipitously” in coming years.

Each of the individual countries insist that those levels will fall.

The BIS says - not a chance and that these increases in debt are untenable.

What you should take note of is what the BIS report says comes next. The BIS says the financial markets won’t permit these debt increases to exist as such.

The only mystery, the BIS report says, is exactly when the markets will intervene.

History shows, the report says, that when the markets do rebel, they often do so instantaneously and decisively – often without much warning.

“When, in the absence of fiscal actions, will investors start demanding a much higher compensation for the risk of holding the increasingly large amounts of public debt that [these countries] are going to issue to finance their extravagant ways?” the BIS economists ask. “The question is when will markets start putting pressure on governments, not if.”

Translation: high interest rates, like what we saw in the late 1970s, are coming.

Meanwhile, in other news...

Yesterday the United States posted their 19th straight monthly budget deficit, $82.69 billion (just for the month of April) - an amount that was nearly four times the $20.91 billion shortfall registered in April 2009 and the largest on record for that month. It was more than twice the $40-billion deficit that Wall Street economists surveyed by Reuters had forecast.

On another front, the 10 Year US Tresury note auction results were also released yesterday. It seems that one quarter of the accepted bids came from direct (anonymous) bidders. This was a huge jump from April and represents the highest participation rate from this group since the crisis began. The drop in primary dealer participation rate to 33% was shocking. Remember these numbers and trends the next time someone suggests the sovereign debt crisis is limited to Europe or within the euro zone. As Zero Hedge noted, "there is no way that the Federal Reserve is not directly or indirectly interfering with auction take downs."

What you will start to see in the coming months is that people around the world will begin waking up to the dire circumstance our western economies are in.

This is already creating a mini-panic and rush on precious metals, a trend which will only intensify.

Reports surfaced yesterday suggesting the panic buying of phyiscal gold in Europe is threatening the depletion of the Austrian Mint. Yesterday the Mint said that it had sold 243,500 ounces of gold in coins and bars in the last 2 weeks. That's more than it sold in the entire first quarter. The Mint reports that the gold orders are coming entirely from Europe and are a sign of "panic buys".

And it's not just gold that is falling to panicked buying from Europeans who openly fear the demise of their currency.

Now, courtesy of Slim Beleggen, it appears the situation in the silver market is just as bad and has spilled over from Austria to Germany. Beleggen suggests the contagion is no longer one of sovereign debt, but of precious metal physical inventory. The primarily silver focused (but holding gold as well) Kronwitter precious metal online retailer is not only not accepting any orders, but has entirely taken down its website.

I have talked about gold on this blog in the past.

In North America there are those who eschew gold/silver as an investment and claim that "gold's only use today is as an inflation hedge as record debt depresses currency values, until fiscal order is restored."

They are right.

The problem though is that people are starting to realize that it is going to be a long, difficult time until 'fiscal order' is restorded.

That's why back on January 11th I said the next big spike would take gold to over $1,650 US an ounce.

I believe we're on our way to that level in the next couple of months.

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