Sunday Post #2: The European Debt Crisis Explained

Blogger Gonzalo Lira has produced an excellent post trying to make the European Debt Crisis understandable for the average joe.

It also succinctly explains why more Quantitative Easing is almost assured.

The European Debt Crisis: This is what happened

In 1999, the Europeans implemented a common currency, the euro. They did it in order to improve trade between the eurozone nations, and thus bind the European countries closer together.

This new currency was centrally managed—that is, there was a single issuer of this new currency. Which of course makes sense: In the United States, you don’t have 50 states issuing currency—you just have the Federal Reserve, issuing dollars for the entire country.

Same with Europe: Thus the eurozone - the zone of countries that had the euro as their currency. This new currency was managed by the European Central Bank - the ECB - out in Frankfurt, Germany. The ECB’s primary concern - like all central banks - was making sure that the currency it was supervising did not lose value. That is, it made sure that inflation stayed below 2% per year.

However, just like in the U.S., though there was a central bank - in this case the ECB -each of the member states of this European Money Union (from where we get the acronym “EMU”) - could issue its own debt.

So far, so good: The euro was printed and managed by the ECB in Frankfurt. The individual countries - pain, France, Germany, Holland - could each issue their own debt, and of course manage their own government budgets.

Now, the strongest economy in Europe is Germany’s. For our purposes, the reasons why of this don’t matter. What matters is, Germany’s cost of borrowing was the lowest of the eurozone.

This makes sense: If I make a million bucks a year, and borrow $10,000 for expenses and stuff, I’m going to get a pretty good interest rate from my credit card company or my bank. You know how lenders are: They lend you an umbrella when it’s sunny, then take it away when it rains. Since I don’t need to borrow the ten grand, all the lenders will trip over themselves to lend me money at extremely low rates, because they know I’m good for it. I won’t default on the debt.

Same with nations - and same with Germany: German debt was always cheap, in the 1%–3% range, because Germany was good for it. After all, it’s the fifth largest economy in the world, and the biggest within the eurozone, racking trade- and fiscal budget surpluses year after year. So who wouldn’t feel comfortable lending money to the Germans? Nobody - ‘cause see the Germans? They pay up - always.

But here comes the problem: Banks felt very comfortable lending money cheaply to Germany. Germany was a member of the eurozone. Therefore, lenders assumed that the other countries in the eurozone were going to be as good a credit risk as Germany.

So the banks lent money to the other, weaker countries in the eurozone at the same rates of interest as they lent to Germany.

Imagine you have a great credit rating - so the bank gives your kid a $100,000 consumer line of credit, just because he happens to live in the same house as you do. The bank lends your kid the money because it says there’s a “tacit promise” that if your kid doesn’t pay back the money, you will.

Crazy, right? Right - but that is the core problem: Countries like Portugal, Italy, Ireland, Greece and Spain - countries whose initials spell out the acronym “PIIGS” - could go into debt at the same rates of interest as Germany, just because they shared the euro as a currency.

The economies of the PIIGS were not as sound as Germany’s - but the lenders treated them as if they were. Not only that, the lenders assumed that, if any country got into trouble - i.e., if any one of the PIIGS couldn’t pay back their loans - the eurozone as a whole would be good for the debt.

This was great for the PIIGS. Because it meant cheap and plentiful loans, with which they could go out and buy stuff.

So they did: The PIIGS went into debt - too much debt  - while the banks gave them all the slack they needed. Which makes complete sense: If before 1999, these countries were borrowing at (say) 6% or more, and all of a sudden their cost of borrowing drops in half, what will they do? Go into debt!

Which is what they did - massively.

And what did these countries do with the debt? Create a false sense of prosperity!

This in a nutshell is what happened between 1999 and 2010, when the Greek crisis first erupted: During those “boom” years (which were really no more than junior going crazy with the credit card), the various countries of the eurozone went into massive debt, in order to both fund a social safety net, and cut taxes on their citizens.

In other words, something for nothing, bought and paid for with cheap debt. Kind of like America. 

Though they now don’t want to admit it, the Germans encouraged this over-indebtedness, by the way - as did the French. Why? Because with this false sense of prosperity, the over-indebted nations bought German and French goods and services. German and French banks were at the forefront of lending money to the PIIGS - which essentially made the whole scheme nothing more than vendor financing on a massive scale: I lend you money so that you can buy my products.

Just like a junkie setting up an addict, or a predatory credit card company giving you teaser rates, the Germans and the French - via their banks and government institutions—gave the weaker economies all the incentive in the world to go into massive debt, and then go out and buy German and French products.

It was bound to end in tears. As is happening now. It all goes to the issue that all these countries are over-indebted. And that overindebtedness is being reflected in the sovereign bond markets.

Let’s take a slight detour, to explain what this means.

What Are Bonds? What Are Yields? And Why Do They Matter?

A bond is a bit of paper that is traded, just like stocks. But unlike a stock, which is a piece of ownership in a company, a bond is essentially a promissory note: You lend me money, and I give you this piece of paper where I promise to pay you back. The bond has a face value, and an interest rate. The person who buys the bond at the market price collects the interest, and receives the principal of the bond on maturation. A person can own a bond, or sell it to someone else, just like a stock.

Corporations issue bonds, in order to finance factories, expansion, whathaveyou. And governments issue bonds, in order to finance various infrastructure projects, as well as their deficit spending.

With all bonds, there are three pieces you have to understand: There is the face-value of the bond, there is the interest that the bond pays, and then there’s the effective return-on-investment of the bond—which is known as the yield.

The yield of a bond is what everyone pays attention to. The yield on a bond is a percentage value: It is the interest rate of the bond, times the face value of the bond, divided by the current price of the bond. The yield is inversely affected by the price of the bond: The higher the price of the bond, the lower the yield, and vice versa.

So you see, it’s a seesaw: When the yield of the bond is going up, then the price of the bond is going down. When the yield is going down, then the price of the bond is going up.

Let’s see an example: Say I sell you a bond for €1,000, paying 5% interest per year. The bond is trading in the open markets at €900. So 5% times €1,000, divided by €900, equals 5.55%—the yield has widened, as they say in the biz. That is, the yield has gone up, since the price of the bond has gone down.

But say instead that the bond has risen in value, which of course can happen: Say the price is up to €1,100 per bond. So 5% (the original interest) time €1,000 (the face value), divided by €1,100 (the current price, gives us a yield of 4.54%. The bond’s yield is said to be narrowing.

Since bonds all have different conditions insofar as maturation, interest rate, etc., it is simpler and quicker to speak of changes in yield only: “The yield is rising” means that the price of the bond is going down.

Why is the price of a bond going down? Because investors think that the person who owes the debt—the bond issuer—is not necessarily good for the debt. That is, they think the debtor might default. So the owners of the bond sell it at a lower price, because they don’t want to have the risk of a default.

Why does a bond go up in price? Because the debtor might show signs that it won’t default—so the high yield makes it attractive for a buyer to pay more for the bond, thereby driving up the price, thus paradoxically lowering the yield of the bond.

So what does this mean for countries?

Well, when the yield of a government bond rises, it means that people are selling that country’s bonds. Take the above example of €1,000 bonds paying 5%. If the bonds are now at €900, the yield is at 5.55%, as per the above example.

Now, if the yield on that bond rises to 7%, what does that mean? It means that the bond is trading at distressed levels. Because for a €1,000 bond paying 5% interest to be yielding 7%, then the bond is trading in the €715 range. (The face-value price of €1,000 times 5% divided by a current price of €715 yields 7%.)

So say you’re a government, and you have to fund €1 billion for a bridge. You will issue bonds to finance the bridge, bonds that will pay an interest of 5% a year. In order to raise those billion euros, you have to sell not a million €1,000 bonds—you have to sell 1,400,000 bonds with a face value of €1,000.

And therefore, you have to pay interest on 1,400,000 bonds, instead of 1,000,000 bonds. And when these bonds mature—that is, when they have to be paid off in full—the government won’t be paying out €1 billion in principal: They’ll be paying out €1.4 billion in principal, on what was supposed to be a €1 billion bridge. Because bonds are paid full face value on maturation.

Thus a government’s cost of borrowing has risen. And it’s all expressed in the yield.

That’s why yields matter. And unfortunately, rising yields is what’s been going on with European debt: They have risen massively—because investors think there is a less likelihood that the bonds will be paid back in full.

Why does this matter? Because these nations are all relying on deficit spending: They spend more money than they bring in. So they need to issue more debt, in order to pay off their obligations, such as salaries, pensions, medical care, not to mention pay off the interest on the previous bonds they’ve already issued.

So in this situation, a country can get to the point where its bonds are selling at such a discounted value that it cannot issue enough bonds to simultaneously pay off their obligations and allow them to continue to function at their current level.

That is, countries can get to the point of bankruptcy—depending on how high the yields on their bonds rise.

Now, About Greece

This is what happened to Greece: Its cost of borrowing rose so much that they no longer had the ability to raise the cash to pay off all their obligations.

So starting in April of 2010, the so-called Troika—the International Monetary Fund (IMF), the European Central Bank (ECB), and the European Commission (EC, the executive arm of the European Union)—structured a bailout package, which was eventually passed through in June.

The bailout package of course had some conditions, which the Greeks agreed to in order to get the money—and which they then promptly failed to live up to.

The details aren’t that important for the purposes of this discussion. What matters about the Greek Drama is two-fold:

• One, Greece is a small economy within the EMU—about 2% of the eurozone’s GDP—so therefore its debts, while massive, were all-in-all manageable.
• Two, the bailout of Greece was supposed to be swift and decisive, and act as a signal to the markets that the Troika would defend the eurozone, and not allow any of its members to go bankrupt. In other words, Greece was a firewall, to protect the other economies.

But the problem was, the Troika dithered.

Why did they dither? Because it became immediately clear that the only way to fix the Greek situation was by debt haircuts—and haircuts were impossible, because they would bankrupt the European banks. And the American ones too.

Fear of a Credit Event

Part of any debt restructuring—be it a poor man’s bankruptcy, or the bankruptcy of a large corporation—is debt haircuts: That is, lenders get less than the 100% of the debt that they are owed.

Say I owe $10,000 to a car dealership for a new car I bought last year, and I go bankrupt. The dealer will get a percentage of the money I have left after everything (including the car) is liquidated. But they won’t get the full $10,000 that I owe them, obviously, because I’m bankrupt: I owe more than I have.

Same with nations: Greece owed more than they had—so Greece’s lenders were going to have to take a haircut. That is, they would have to take less money than they were owed.

This is what’s known as a “credit event”.

This was a problem.

If there was a haircut on Greek debt—a credit event—then the banks and insurance companies which held the debt (predominantly German and French banks) would have to write a loss on those loans. Huge losses. Losses bigger than their capital.

Thus these banks would go bankrupt, if there was a credit event in Greek debt.

Even if they didn’t go bankrupt, these financial institutions would have to sell off other bonds, in order to raise the cash to stave off bankruptcy.

This massive sell-off of sovereign bonds would have a contagion effect: In order to cover their Greek bond losses, banks would have to sell their Italian, Spanish and French bonds—at a loss—so as to raise the cash to stay solvent, which would in turn make Italian, Spanish and French debt toxic.

In other words, a domino effect.

Furthermore, American banks—which don’t own much in the way of PIIGS debt directly—have written a lot of insurance on those sovereign bonds: The famed credit default swaps (CDS). Bank of America especially has made a lot of money selling CDS’s on those debts in 2008, 2009 and 2010, as has JPMorgan.

If those sovereign bonds defaulted, those American banks would have to pay off these CDS’s—

—and thus they would go bankrupt too!

Everything is connected: A credit event in Greek bonds would trigger credit events in Italian, Spanish and eventually French bonds, which would bankrupt European banks as well as American banks—

—basically, a repeat of the 2008 Global Financial Crisis, only bigger, and without the happy ending.

This is why the Troika dithered. They talked tough, and they even put the gun to Greece’s head: Pass these austerity measures, or else no bailout money. But they never pulled the trigger and let Greece fail—because if they did, the European and American banking sector would collapse.

Since the Greek financial hole grew bigger between 2010 and 2011—because the Greek’s didn’t live up to most of their promises—a second bailout package had to be created.

Again—more dithering. This time, the dithering was because the Germans in particular feel that they are propping up spendthrift countries—and nobody likes to feel like the chump who’s paying for other people’s good times.

There is enormous political pressure on Merkel to not save Greece. The people pressuring Merkel don’t realize what will happen if Greece collapses.

So then last October 28, the Troika plus German Chancellor Angela Merkel and French President Nicolas Sarkozy finally came up with a “solution” to the Greek Drama.

“Solution” is used in the loosest possible sense of the word: In the weeks previous to the Oct. 28 announcement, the Europeans had been going around the world, hat in hand, asking emerging markets—especially China—to fund their bailout facility. They had been politely refused—because they’re not stupid: They saw that the bailout facility—the famed European Financial Stability Facility (EFSF)—was just a lot of smoke and mirrors, essentially throwing good money after bad.

Through some clever accounting tricks and some not-so-clever baldfaced lies involving accounting standards, the Europeans managed to cobble together a workable EFSF which could give Greece and potentially one of the other PIIGS a lifeline.

But in order to show that they were “serious”, the Troika and Merkel and Sarkozy insisted that the Greeks agree to a serious of painful austerity measures.

The big news, however, was that this second bailout of Greece included haircuts on Greek debt. The advertised number on the Greek haircuts was fifty percent! (Though when you looked more closely at the details, it was more like 20%.) The Oct. 28 deal stipulated that the haircuts on the Greek debt would be voluntary—“voluntary” as opposed to “forced”, which would have triggered a credit event)—

—but then on the following Monday, Georgios Papandreou, the Prime Minister of Greece, threw a monkey wrench into the Rube Goldberg contraption that is the Second Greek Bailout Package:

G-Pap called for a popular referendum of the bailout!

All hell broke loose.

The eurocrats famously do not like going to the public to ask for their support—they like to dictate instead. Why? Because they consistently lose the popular vote, to the point where they no longer bother putting things up for a vote.

For Papandreou to put the austerity package to a popular referendum meant that it would likely not pass—because no citizenry likes to be asked if they want their government to give them less services and entitlements (duh!).

Therefore, the Troika suspended the €8 billion tranche of the first bailout package that the Greeks were supposed to get in November.

Without that tranche, Greece goes bankrupt on December 15.

So Papandreou backtracked on Thursday, November 3, and said that there would be no referendum.

But the damage was done: The bond markets got so freaked out that they started looking at the next weak link in the European chain.

Enter Italy

In mid October, Italian debt was yielding about 3.5%—very respectable. Italy, furthermore, has a very large debt, but it is far from insolvent: In fact its government regularly meets its budget with a bit of a surplus. Balance of trade is okay, growth is low but in line with the rest of Europe. And aside from periodice sex scandals, the Berlusconi government is fairly competent and efficient.

Overall, Italy is in pretty good shape.

But it needs more debt to pay off previous debts, and to shore up its economy, which is in a recession much like the rest of the world’s. It’s debt load is growing, but strictly because its government is spending to prop up the sagging Italian economy.

Nevertheless, after the Greek fiasco, the bond markets turned on Italy.

On the Monday after the Greek Week (Nov. 7), Italian yields rose from their 5% level—then spiked on Wednesday to above 7.6%, which is potentially catastrophic. Why catastrophic? Because at those levels, no advanced economy can finance itself—not to mention the fact that certain derivatives require that yields stay below certain thresholds. If they remain above certain yield numbers for a set period of time, they are considered credit events—which triggers CDS’s, which lead to bank bankruptcies.

So those yields have to go down now—fast.

This crisis in Italy has led Silvio Berlusconi to resign, once austerity measures are passed. His resignation will likely calm the markets—for a bit.

What is striking is the inanity of the eurocrats’ response. They come up with vague and flimsy packages, and a lot of flowery rhetoric—you should have just heard Sarkozy, after the Oct. 28 deal, going all French Literature on the thing.

But the Europeans don’t seem to understand that they have a nuclear weapon at their disposal—which they refuse to use.

And that nuclear weapon in the European Central Bank.

Fear of Monetization

The easiest way to fix this entire debt situation would be for the European Central Bank to simply print up money, and go out and buy enough Greek and Italian debt to bring down their yields.

It wouldn’t even have to be very much—a mere €50 billion would do the trick. The fear that the markets would have of being caught on the wrong side of a trade against the ECB would be enough to keep the markets docile and quiet.

And this is where more QE is almost assured.

 You have to stabilize the patient, before you give him the treatment—not operate him for liver cancer while he’s still bleeding from a gunshot wound to the leg.

Having the ECB come in and decisely calm the markets—like the Swiss National Bank did a month ago—would be the best way to get the European house in order, and then implement the structural reforms and austerity measures that everyone agrees need to be implemented.

But the ECB isn’t stabilizing the patient. Why? Because the Germans are greedy.

If the ECB does a European version of Quantitative Easing, the Germans are afraid that their currency will weaken—which they do not want, because they are a creditor nation. If the euro’s value erodes, then Germany will have lost some purchasing power.

They are so afraid of the euro weakening—and thus the Germans losing a bit of their surplus—that they are making the other economies in the eurozone crash.

The Germans do not seem to understand that, if the nations of Europe go down, there will be no buyers for their goods and services—so they will suffer too.

Thus the ECB sits there, while this Greek problem becomes now an Italian problem—

—and soon a French problem: The yields of French bonds are rising precipitously, and already one French bank, Credit Agricole, is in trouble over the Greek Drama. It’s only a matter of time before the big French banks start tumbling—and then France itself—unless the bond markets are calmed.

So What’s Going To Happen?

At some point the Germans are going to come to their senses, and the ECB will start buying up European sovereign debt, calming the markets. Greece and a couple of other small and/or weak eurozone countries exit the European Monetary Union, go back to local currencies, devalue, and then rebuild their economies; say Greece, Portugal, Spain and maybe Italy. And finally, austerity measures are imposed, fiscal budgets are put on a sounder footing, and things right themselves in a few years.

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Mon Post#2: "The Collapse is coming..."

Stunning interview on BBC today, the kind of which you will NEVER see on North American financial TV.

UK trader Alessio Rastani shines in this three-and-a-half-minute interview where he says what most know but simply ignore:

• "This economic crisis is like a cancer, if you just wait and wait hoping it is going to go away, just like a cancer it is going to grow and it will be too late!"

It's a painfully frank interview and shows you how some view opportunity in what others view as crisis.

Speaking of crisis, the harsh reality is that nothing has been fixed in the financial system since the Great 2008 Financial Crisis.

All government has done is paper over the problems and pushed the problems down the road.

In Europe, as Greece teeters on the brink of collapse, it's the world's banks that are at risk from the contagion.

And the banks are still in serious trouble. 

One European banker recently said, "it is an open secret that numerous European banks would not survive having to revalue sovereign debt held on the banking book at market levels."

Mark to Market accounting is the great lie of the banking system right now. Instead of valuing the assets on their books at what they can be sold for today, we have this fantasyland-esque hope that values assets at what they 'think' they will get for them a couple of decades in the future.

European and North American banks are being kept alive with phony accounting.

This was not the case in 2008. Now we have insolvent banks AND phony bookkeeping to make them appear solvent. The problem has only been kicked down the road.

But the desperate efforts to ignore the problem continue. EU finance ministers are taking criticism from around the globe because they are not printing enough money to bail out their banks.

Yesterday, Reuters reported,

• “After a weekend of being told by the United States, China and other countries that they must get more aggressive in their crisis response, European officials focused on ways to beef up their existing 440 billion-euro rescue fund. Deep differences remained over whether the European Central Bank should commit more of its massive resources to shoring up Europe’s banks and help struggling euro zone member countries.”

The Telegraph is now reporting on how German and French authorities have begun work on a three-pronged strategy  to build a “firebreak” around Greece, Portugal and Ireland to prevent the crisis spreading to Italy and Spain, countries considered “too big to bail”.

The reality is that the banks are still in just as much trouble as they were in 2008, and probably more.

Lost in the blizzard of economic news last week were the downgrades of three very big U.S. banks.

There was zero talk of downgrades in 2008, and now Moody’s has cut the debt rating of Bank of America, Wells Fargo and Citigroup.

To paraphrase UK trader Alessio Rastani, the economic crisis is like a cancer. And it's growing.

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Sun Post #2: The Great Greek Domino (updated)

Over the counter (OTC) derivatives and credit default swaps (CDS) are mysterious terms that have been brought to the forefront since the 2008 Financial Crisis.

But it's important you understand what they are and what their implications are for the economy, monetary policy and their impact on Silver and Gold.

A derivative instrument is a contract between two parties that specifies conditions—in particular, dates and the resulting values of the underlying variables—under which payments, or payoffs, are to be made between the parties.

Within the derivatives markets, many products are traded through exchanges. An exchange has the benefit of facilitating liquidity and also mitigates all credit risk concerning the default of a member of the exchange.

Facilitating liquidity and mitigating credit risk is what derivatives are all about.

Products traded on the exchange must be well standardised to transparent trading.

But there are non-standard products ttraded in the so-called over-the-counter (OTC) derivatives markets.

OTC derivatives have less standard structure and are traded bilaterally (between two parties). OTC derivatives are significant in the asset classes such as interest rate, foreign exchange, equities and commodities.

They have become a crucial part of the world of global finance. The OTC derivatives markets have grown exponentially over the last two decades and have been driven by interest rate products, foreign exchange instruments and credit default swaps.

The notional outstanding of OTC derivatives markets has risen to the point where they totaled approximately US$601 trillion at December 31, 2010.

If something were to occur where payouts had to be made on only a small portion of this US$601 trillion total, the outcome could be catastrophic.

Many believe OTC derivatives and credit default swaps are financial instruments which are out of control.  Warren Buffet once called them "financial weapons of mass destruction. Time bombs that could harm the whole economic system".

Are those 'time bombs' about the detonate?

Enter the rapidly evolving sovereign debt situation in Europe.  Suddenly Buffet's famous derivatives statement is brought into sharp focus.

Europe is preparing for a domino to collapse that could set these "financial weapons of mass destruction" into motion.

Today the German newspaper der Spiegel announced that the German Finance Minister is preparing for a Greek bankruptcy.

• "German Finance Minister Wolfgang Schäuble, who is reportedly doubtful that the country can be saved from bankruptcy, is preparing for the possibility of Greek insolvency. Officials in his ministry are currently reviewing scenarios for handling such a situation, exploring what it might mean for the rest of the euro zone."

The key concern of a Greek bankruptcy is that it could trigger a massive credit crunch larger than the one triggered by the collapse of Lehman Bros in 2008.

Credit lines provided to countries like Spain or Italy could evaporate if investors stop lending them money after a Greek bankruptcy.

Then there is the question of what happens to all the trillions in other interconnected debt.

Tonight every one's attention is focused on remembering the 10 year anniversary of the terrorist attacks of September 11th, 2001.

But tomorrow attention will return to Europe and the impending collapse of the Great Greek Domino.

The focus will be preventing these 'time bombs' from destroying the entire economic system.

 Can you say: "Ramp the paper money Printing Presses up even higher?"

Sure you can.

It is inevitable.

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Jon Stewart on Derivatives and the Greek Crisis

Last night Jon Stewart had a great take on the Greek Crisis which summarized many of the points from yesterday's post, including how America's debt situation is actually worse that Greece and how no one knows the impact of the derivatives mess.

Unfortunately I can't embed a clip from the show, however if you follow this link you can watch the segment (if you are viewing from Canada) on the Comedy Network.

If you are in the United States, go to http://www.thedailyshow.com and it's the first segment on the June 22nd, 2011 show.

There is an audio version of the segment on youtube put to assorted pictures here:

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Greece, the PIIGS and why it is so important

On a day where the main distraction is Ben Bernanke, the Federal Reserve and QE3, the real story remains Greece and the PIIGS of Europe (Portugal, Ireland, Iceland, Greece and Spain).

This issue has never really gone away.  And the average person really doesn't have a clue what all the fuss is about.

Oh sure... it's about sovereign debt, but no one really knows much beyond that.

It all has to do with derivatives, that obscure financial concept that everyone seems to have vaguely heard about but no one seems to really understand.

Derivatives are financial instruments that were created to reduce risk, and their use on Wall Street is known as hedging.

In recent years their prevalence and complexity has ballooned creating new kinds of risk.  The name "derivative'' comes from the fact that their value "derives" from underlying assets like stocks, bonds and commodities.

In the years leading up to the financial crash, banks made billions by selling complex derivative contracts directly to buyers, pocketing hefty fees but absorbing considerable risk as well.

And it is that risk that is the problem.

Although America’s housing collapse is often cited as having caused the financial crisis, the system was vulnerable because of intricate financial contracts known as credit derivatives, which insure debt holders against default. They are fashioned privately and beyond the ken of regulators - sometimes even beyond the understanding of executives peddling them

Originally intended to diminish risk and spread prosperity, these inventions instead magnified the impact of bad mortgages like the ones that felled Bear Stearns and Lehman Bros.

In the case of A.I.G., the derivative virus exploded from a freewheeling little 377-person unit in London, and flourished in a climate of opulent pay, lax oversight and blind faith in financial risk models.

By 2008 these derivatives nearly decimated A.I.G, one of the world’s most admired companies which had seemed to be a sturdy insurer with a trillion-dollar balance sheet, 116,000 employees and operations in 130 countries.       

When all was said and done, A.I.G. needed a $182 billion dollar federal bailout.  And it was all because of these infernal 'derivatives'.

In years past, when financial crises in Argentina and Russia left those countries unable to make good on their government debts, they simply defaulted.

But this time around, credit default swaps and other sorts of derivative contracts have become so common and so intertwined in the financial markets that there are fears among regulators and financial players that a Greek default will wreak havoc among derivatives holders.  

The looming uncertainties are whether these derivative contracts - which insure against possibilities like a Greek default - are concentrated in the hands of a few companies, and if these companies will be able to pay out billions of dollars to cover losses during a default.

If there were a single company standing behind many of these contracts, that company would become the A.I.G. of the euro crisis.

     

The central banks of both Europe and the United States will not say whether their researchers have studied holdings of derivative contracts among nonbank entities like insurance companies and hedge funds.

When Ben Bernanke, the chairman of the Federal Reserve, was asked about derivatives tied to Europe at yesterday's press conference, he said:

• “A disorderly default in one of those countries would no doubt roil financial markets globally. It would have a big impact on credit spreads, on stock prices and so on. And so in that respect I think the effects in the United States would be quite significant.”

Derivatives traders and analysts are debating just how much money is involved in these contracts and what sort of threat they pose to markets in Europe and the United States.

According to Markit, a financial data firm based in London, the gross exposure is $78.7 billion for Greece. And there are many other types of contracts, like about $44 billion in other guarantees tied to Greece, according to the Bank of International Settlements.

The gross exposure of the five most financially pressed European Union countries - Portugal, Italy, Ireland, Greece and Spain -  is about $616 billion. And the broader figure on all derivatives from those countries is unknown.       

    

This is why the Europeans have been wrestling this week with the ridiculous “voluntary” Greek bond financing solution.  They are trying to sidestep a default because they simply don' know what's out there.

And they're afraid.

Afraid of an outright default because the financial industry is still refusing to provide the disclosure needed to understand the depth and scope of the actual problem.

Said Christopher Whalen, editor of  the Institutional Risk Analyst: "They’re holding us hostage. The Street doesn’t want you to see what they’ve written.”       

It is suggested that the depth and breadth of the contagion that might occur among swaps holders in the case of a Greek default is massive.

European leaders have said there’s no way we’re going to let Greece default even though it is abundantly clear to everyone that this is the best solution - just as it was for Argentina and Russia several years ago.

Skeptics fear their commitment is so severe because they aren't really sure what they are dealing with.

When asked what data the Federal Reserve had collected on American financial companies and their swaps tied to European debt, Barbara Hagenbaugh, a spokeswoman, referred to a speech made by Mr. Bernanke last May in which he did not mention derivatives tied to Greece.

At yesterday's press conference, Bernanke said that commonly cited data on derivatives do not take into account the offsetting positions banks have on their Greek exposures. And with those positions, he said, even if there is a Greek default, “the effects are very small.”

(This, of course, is the same Ben Bernanke who swore up and down to congress in 2006 that the subprime mortgage condition was also 'very small' and would not be an issue)

At the European Central Bank, Eszter Miltenyi, a spokeswoman, said: “This is much too sensitive I think for us to have a conversation on this.”           

It is widely believed by many insiders that the financial industry's process for unwinding credit-default swaps couldn't possibly run smoothly if Greece defaulted.

Derivatives tied to a country’s debt do not pay out over time, they pay out on one occasion: if a default occurs. That makes sovereign derivatives  similar to derivatives on corporate bonds and different in some ways from the situation at A.I.G. Under normal circumstances they can be unwound smoothly.  But not if the risk were concentrated in just a few weak institutions.

Derivatives have been called the 'financial instruments of mass destruction'.

Will the derivatives of the PIIGS blow up the financial world the same way the derivatives of Bear Stearns, Lehman Bros and A.I.G. did?

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If Greece Is Bear Stearns, Will the UK Be Lehman?

Great little piece on CNBC yesterday which posed the above titled European debt contagion question.

Sunday’s news of a 750 billion euros ($951 billion) stabilization fund and European Central Bank assistance for the European bond market averted a full fledged liquidity crisis, but many remain sceptical that the crisis has past.

Can the governments in Greece and Portugal live up to their end of the bargain and significantly cut government spending in the face of bitter opposition from voters?

“The big question I am asking myself is whether Greece is Bear Stearns,” Anthony Fry, senior managing director at Evercore Partners, said. “What I really fear is that if Greece is Bear Stearns then the UK is Lehman Brothers.”

Fry, it should be noted, worked for Lehman before its collapse.

There is an insistance that the UK will be alright because it has the ability to sell government bonds internally.

Steven Barrow, the head of G10 Research at Standard Bank, holds that opinion. “I am confident about the prospects for the pound,” Barrow said.

The difference between the UK and Greece, according to Barrow, is that Britain has more room for maneuver. “The UK can devalue and print money, the UK will not default, the UK will not need the IMF,” he said.

Sounds like a recipe for currency collapse to me.

And Anthony Fry is adamant that such analysis is nonsense.

“I can’t believe (the UK) can avoid trouble," he said. "The current coalition talks are like arguing over a birthday cake. Once they decide how much of the cake they get they realize no one bothered to bake the cake.”

Fry makes the exact same point I have been making the past few months; with a lot of money needing to be raised over the coming months and years, UK borrowing costs are going to move sharply higher.

“My big fear is that after (Chancellor of the Exchequer) Alistair Darling refused to support the EU/IMF/ECB bailout of the euro zone bond market, the euro zone may stand by and do nothing when the UK gets into trouble,” Fry said.

Fry remains worried about the problems facing Greece will spread to Spain and Portugal despite Sunday night’s unprecedented support.

“Tuesday was a correction post Monday’s huge short squeeze," Gallagher said. "The big question now is whether institutional investors will return to the European bond market.”

Meanwhile Pimco, the world’s largest mutual fund, made the decision to stay clear of a proposed Greek dollar-denominated bond auction last month and that decision was one of the key moments leading up to Sunday’s rescue package. The coming weeks and months, July in particular, will be crucial. That's when €227 billion redemptions come up in the euro zone and with Spain needing to refinance significantly that month.

“What we are likely to see is a two-tier Europe," Michael Gallagher, director of research at IDEAglobal, tpld CNBC. “A double-dip recession in Southern Europe is increasingly likely. Core Europe will slow, but do OK. The outlook to the South is far worse.”

All these agreements are predicated on the EU governments meeting strict budget targets and stepping up debt consolidation efforts. Which means the Achilles Heel in Sunday's agreement is governments resisting expansionary, deficit financing once its economic fortunes begin to falter.

The United States has been unable to break that cycle, what makes anyone think the PIIGS will be able to?

So, if if Greece is Bear Stearns and the UK is Lehman, who will be AIG?

“No comment," Fry said.

I'm willing to be it will be California.

As I said last week: first the PIIGS, then the UK and then... the United States.

Are you prepared?

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Mr. Toad's Wild Ride

An evening post for you.

Mr. Toad's Wild Ride. How else to describe this crazy day in the stock markets?

At one point the DOW had fallen 1,000 points - a drop more precipitous than any day in 2008. By the close that market had recovered - somewhat - and closed down only 430 points.

Only.

Perhaps the most stunning development of the day occurred on the NASDAQ. From Bloomberg:

"Nasdaq OMX Group Inc. said it will cancel all trades of stocks at prices that were 60 percent above or below the last price at 2:40 p.m. or immediately prior. The exchange operator said in a statement it will cancel all trades greater than or less than 60 percent away from the consolidated last print in that security at 14:40:00 or immediately prior. Nasdaq said it coordinated the decision with all other exchanges."

Cancel all trades? Ummm... so the market was crashing big time at the end of the day and the Exchange intervened to say... "never mind, your trades which pummelled stock prices at the end of the day are... cancelled????"

Will tomorrow be Black Friday, 2010?

As I have said all year, the magical rally of the past year is a false recovery.

The bounce off the February lows has resembled a low volume Ponzi scheme. It has been driven by technically oriented buying from the Banks and the hedge funds.

Stunningly the anchors on financial television are trying to blame the sell off on a 'fat finger' order that caused Procter and Gamble to drop 20 points in 45 seconds. Are we to believe a typist inputting an order to sell 16 million shares typed "B" for Billion instead of "M" for Million?

"Oops. Crashed the free world. Sorry about that - my bad."

Bullsh*t.

The market plummetted because of its highly unstable and artificial technical underpinnings. Wall Street right now is nothing more than a casino, dominated by a few big Banks and hedge funds.

I invite you to watch this 7 minute interview with Gerald Celente which echos a lot of what has been said here all year:



Meanwhile we now learn that the US Federal Reserve is printing up another $105 billion to send to Greece to help with its debt problem.

Huh?

Why?

Is it being done to bail out more US Banks?

You know, the ones we were told had little exposure to sour European debt? Last week Bloomberg reported that JPMorgan Chase & Co., the second- biggest U.S. bank by assets, has a larger exposure than any of its peers to Portugal, Italy, Ireland, Greece and Spain. JPMorgan’s exposure to the five so-called PIIGS countries is $36.3 billion, equating to 28% of the firm’s Tier-1 capital, a measure of financial strength, Meanwhile Morgan Stanley holds $32.4 billion of debt in the region, which equates to 69% of its Tier 1 capital.

Make no mistake. Bernanke isn't supplying Greece with $105 billion in bailout money to save Greece. He's actually bailing out U.S. Banks—again!

Quantitative Easing is plowing ahead full bore. And we are going to reach a point where nothing will be able to stop this money from eventually entering the money supply.

And when it does, inflation is going to hit with a vengence.

1981 is going to look like a cakewalk of cheap interest rates when all this finally plays out.

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First the PIGS, then the UK, then the United States

The biggest fear from the debt saga playing out in Greece right now is contagion.

Concern is rampant that next up will Portugal, Italy, and Spain. After that will come the UK. And finally the problems will spread to the United States.

Imagine if you could turn back time... back to, say, 2006/2007.

If you saw Goldman Sachs betting against their own mortgages, betting on a complete US mortgage meltdown, would you invest differently?

Knowing what you know now, would you take steps to prepare, perhaps even position yourself to take advantage if the big banks were making similar such bets?

Well, according to a wall street journal report, big banks like JP Morgan, Bank of America, and Citigroup are preparing for that contagion's spread to new world by buying financial instruments that essentially allow them to short sell (or bet against) U.S. cities and states.

These banks are trading in so-called municipal credit default swaps which can be used by investors to bet that insurance contracts protecting holders of municipal bonds will default.

Some states say the derivatives not only scare away potential buyers of municipal bonds by creating a perception of risk, but ultimately drive up states' borrowing costs.

The California treasurer is just one of a number of state treasurers that have launched a probe into the sale of these derivatives and the sale of municipal bonds by big Wall Street firms that might reveal "speculative abuse of CDS in the muni market," says one regulator.

Clearly these big US banks see a looming debt crisis in the United States and fully expect the Greek contagion to work it's way to North America.

Of course if individual US States or cities go bust, the US federal government will have to bail them out.

Which means printing more money, injecting more liquidity into the system, etc.

What was it that Bernanke said about the basic laws of arthmetic?

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Ple

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No laws are more basic than the laws of arithmetic

So what is quickly developing as the central story in world finances right now?

Sovereign debt.

And yesterday there was a dramatic worsening of the eurozone sovereign debt crisis as Standard and Poor's downgraded Greece's credit rating by three notches to junk status, citing concerns about the country's ability to implement the reforms needed to slash its budget deficit.

The agency also cut Portugal's rating by two notches to A minus.

This, of course, led to heavy falls for European and US equities as investors sought sanctuary in German and US government debt, gold and the dollar.

The moves came towards the end of a European session that saw mounting uncertainty over whether Greece would secure financial aid in time to meet a refinancing deadline on May 19.

In view of the popular opposition in Germany to helping Greece, markets have grown increasingly concerned about just how Angela Merkel, Germany's chancellor, can push the country towards participating in a bail-out.

Jane Foley at Forex.com said: "If Germany doesn't come through with a loan for Greece, it would seem unreasonable to expect cash-strapped economies such as Spain, Ireland and Portugal to help make good the shortfall - meaning that an EU loan could yet fail. Even if Germany does present a loan to Greece, there would be no guarantee that there would be an end to Greece's problems. Until Greece can prove it can live within its means its bond yields will carry an inflated risk premium on the open market reflective of higher default risk."

Five-year credit default swaps on Greek government debt, a measure of insuring against debt default, hit a record yesterday of 800 basis points, up from 710bp on Monday. The spread of Greek 10-year government bond yields over Bunds - the premium demanded by investors to hold Greek rather than German debt - hit a record wide of 718bp.

"Risks are mounting and governments should move swiftly to take additional corrective measures to improve their outlook and bolster market confidence."

What is most interesting is the way investors are seeking sanctuary in the the US dollar and US Treasuries.

Mark my words... it will be a shortlived strategy.

As has been stated on this blog earlier this year, the UK and the US are not that far removed from Greece and Portugal.

In fact on the very day all this transpires, US Federal Reserve Chairman Ben Bernanke is warning the United States that America's debt is unsustainable.

And perhaps the most significant quote was this little gem: "Failure to cut the deficits would push interest rates higher - not only for Americans buying cars, homes and other things - but also for the government to service its debt payments," Bernanke said.

Which brings us to our insular little world in the Village on the Edge of the Rainforest.

So many of the R/E cheerleaders living in denial and delusion have clung to Bernanke's comments about keeping the Federal funds rate low for an extended period of time, even as the economy appears to be recovering.

But as I have cautioned time and time again, that does not mean interest rates for the common mortgage holder won't rise.

Today Bernanke came out and said so.

What is happening in Greece and Portugal today will - soon enough - play out in the UK and the United States.

Many of the individual States in America are in dire financial straights. And the federal balance sheet, as Bernanke notes, is unsustainable.

"No laws are more basic than the laws of arithmetic: For fiscal sustainability, whatever level of spending is chosen, revenues must be sufficient to sustain that spending in the long run," Bernanke told President Barack Obama’s commission to tackle the soaring deficit yesterday.

The bond market is going to drive interest rates up.

And I don't think it's a stretch to imagine that if the Bank of Canada raises the BoC rate by 3% over the next six months that the bond market also won't drive up rates an additional 3% as well (we've already seen them boost rates 1% with no raises from the BoC).

That would be a rate increase of 6% added to the current five year rate of 6.25%; for a mortgage rate of 12.5%.

Perhaps that's why BoC Governor Mark Carney was telling a Parliamentary committee that Canadians should get ready for more expensive money and less expensive houses. “We see a marked weakening in housing over the course of our projection (into 2012), starting from the second quarter of this year and over the balance,” he said.

Central Bankers choose their words with extraordinary care.

And when Carney says he sees a "marked weakening in housing" between now and 2012, you should pay particular attention.

Perhaps he sees what a 12.5% mortgage rate will do to it.

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Black Swan

Notwithstanding recommendations from the likes of the CD Howe Institute, the reality is that the Bank of Canada is going to have to dramatically increase the bank rate here very shortly.

StatsCan reports that growth was a blistering 5% in the last few months of 2009, way above expectations. Virtually every mainstream economist is now saying that the Bank of Canada has every justification it needs to start in on a string of interest rate increases, starting in about 3 months.

The surging economy "increases the odds the Bank of Canada will begin to hike interest rates in July and stay on that path in the following decisions,” says the Bank of Montreal.

Rates are going up.

The only question is: 'how fast' and 'by how much'.

Which brings us back to the issue of sovereign debt and Greece.

The image posted above are the Debt vs. GDP ratios of the world's larger economies according to the Wall Street Journal (click on image to enlarge).

Note that Greece's debt versus GDP sits at a shade over 125% versus the USA's near 100% ratio. Japan comes in as the debt champion at a 200% debt load versus GDP.

So... ummm... exactly how is the western world all that different from the Greeks?

The answer is that the Greeks don't have a currency that they can devalue in order to help inflate themselves out of their debt.

Japan would be toast right now if they were in the same situation with a currency like the Euro that they couldn't manipulate.

Because the Greeks don't have this ability, it has increased the perception of the risk that Greece could possibly default. That's what's making it very costly for Greece to sell bonds in order to fund itself.

What's amusing is watching the central banks in the UK and Japan scramble to avoid becoming the next Greece. The British Pound has taken a brutal beating as some speculators believe England may be the next country to suffocate in their own debt.

But as we noted two days ago, there is no smugness in watching what is playing out overseas because even Ben Bernanke and Alan Greenspan are concerned.

And with good reason. USA government debt is 90% vs. GDP as opposed to the 130% debt vs. GDP ratio in Greece. Anyone who thinks the US is at a lower risk than Greece is only deluding themselves. It's much like telling yourself that you are at a lower risk of having a heart attack when you are 290lbs versus being 330lbs!

The biggest worry is that investors begin to panic over the sovereign debt worries of several countries all around the world.

This could potentially trigger a wild fire as the world realizes that all of the modern economies minus China have the same problem.

The subprime crisis is a good example of watching how one tiny domino can make them all come tumbling down. If the debt spreads begin to blow out on the sovereign debt of several countries like the spreads blew out in the United States with mortgage backed securities back in 2008, then we are going to see one hell of a fiscal tidal wave.

As we have already noted... Bernanke and Greenspan both see the threat and have been moved to comment publicly on it.

Greenspan keeps daily watch on the interest rate on 10-year Treasury notes and 30-year Treasury bonds and calls them the "critical Achilles' heel" of the economy.

And that's because those spreads could spin wildly out of the control of his buddy, Ben Bernanke, at a moment's notice.

It represents the quintessential 'black swan' occurrence; those high-impact, hard-to-predict events that are beyond the realm of normal expectations.

But I ask you... would such a scenario really be all that unexpected right now? And just how stupid is it if you don't make moves to protect yourself?

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PIIGS, Dubai, America and Debt

As the world watched the markets melt down in 2008, I commented constantly that what we were experiencing was a deep, financial earthquake the repercussions of which we do not fully appreciate or understand.

I maintain that viewpoint even today.

The chain of events set into motion in 2008 still have a long way to play out.

I have posted here numerous times before about the massive amount of private debt that has accumulated and how the system needs to allow this debt to unwind, no matter how painful this process will be (and it will be painful).

We cannot have meaningful recovery until this happens.

But Western governments have not allowed this to happen. They have intervened to prevent the pain. And no region has been shielded more than Canada, in general, and Vancouver, in particular.

Emergency interest rates and stimulus spending have been the most visible signs of this intervention.

But we are only delaying the reckoning.

And as the months go by, the shenanigans are exposing themselves.

Subprime mortgages in the United States were only a small tip of the iceberg, the first element to fall. Now the problem has spread to all areas of the housing market.

Investments built on that sham of the real estate bubble have crumbled all over the world, and in turn have crippled industry after industry.

In Europe, we are now coming to understand how Goldman Sachs Group Inc. (through it's management of $15 billion of bond sales for Greece) arranged a currency swap that allowed the Greek government to hide the extent of its deficit. The New York-based firm helped Greece raise $1 billion of off-balance-sheet funding in 2002 through the swap, which European Union regulators said they knew nothing about until recent days. Greece’s vast deficits caused it to fail the criteria for joining the single European currency in 1999, but it succeeded in 2001. With this manipulation by Goldman Sachs, Greece was able to gain entry into the European Union.

Now as debt caves in on itself, the situations in Greece, Ireland, Italy, Spain and Portugal are wrecking havoc.

Then there is Dubai. Temporary fixes have created some breathing room but clear warnings are coming out that time is running out for the country to restructure its debt and pull itself out of economic danger.

But nowhere is the mountain of debt more worrisome than in the United States.

"It keeps me awake at night, looking at all that red ink," said President Obama in Nashua, N.H., on Feb. 2. "Most of it is structural and we inherited it. The only way that we are going to fix it is if both parties come together and start making some tough decisions about our long-term priorities."

Over the past year alone, the amount the U.S. government owes its lenders has grown to more than half the country's entire economic output, or gross domestic product.

Even more alarming, experts say, is that those figures will climb to an unprecedented 200% of GDP by 2038 without a dramatic shift in course.

Keep in mind that the European countries are threatened by this very debt to GDP ratio. On a vulnerability index, the United States ranks 9th.

But what is looming in the coming months is going to place the United States in the same cross hairs currently confronted by the PIIGS and Dubai.

Symptoms of the looming problem can be seen in rising homelessness in rural and suburban America that is becoming so bad it is straining shelters, all the result of a perfect storm of foreclosures, unemployment and a shortage of affordable housing.

40 of America's states are in deep financial trouble. But none more so than California.

California's situation has been compared in relation to the United States what Greece is to Europe. But that downplays the significance.

Were it a country, the state's economy would rank eighth in the world - roughly the size of France and much larger than any of the so-called PIIGS. Portugal' economy is ranked 50th in the world, Ireland's is 56th, Italy's is 11th, Greece's is 34th and Spain's is ranked 13th.

Mighty California is drowning in debt. And it has shown itself incapable of managing its finances in recent years. It's now facing a $20-billion (U.S.) budget shortfall in the current fiscal year, and another big gap in 2011. Even with brutal planned cuts to government services and dramatic tax hikes, Republican Governor Arnold Schwarzenegger has asked for nearly $7-billion from Washington to fill the gap - a sum he is unlikely to get.

The shortfall equals a whopping 22% of the state's GDP. That compares with a projected 10.6% of GDP this year for the U.S. federal government's record deficit.

California can borrow money to build roads, schools and other capital projects that the State needs to fund, but it currently has $94-billion worth of bonds outstanding. And the ongoing expenses of government - education, health care, policing, jails, social services and the like - must be paid for out of this year's revenue.

When you combine the fact that more than 40 US states are headed for shortfalls, you start to get a sense of the looming crisis.

Those states cumulatively have a record $194-billion hole to fill, equal to 28% of total state budgets. And it's forecast that there will be another $180-billion gap in 2011.

The inescapable truth is that the mounting toll of unmet state obligations - more than $350-billion in 2010 and 2011 - compounds the debt threat facing the United States. Foreign investors, who help finance all that borrowing, will not much care who the debt actually belongs to.

We are now entering a time where the big players in the market are shorting the debt of soverign countries just like they did with the financial companies. Money is being made by taking countries down, all without a single shot being fired. How long before this mania turns to America?

The US government is either going to have to print money (and actually stick it into circulation - thus triggering hyper inflation) or the cost of borrowing money is going to skyrocket as hundreds or Sovereign nations, states, provinces and municipal governments pursue a limited supply of money.

We've lived through a 12 year period of historically low interest rates. That era is coming to an end. And it's not all that hard to see why.

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For those who enjoy the pics I have posted on the Olympics, you can see more updates on this sub-site I have created. All future photo updates will be uploaded on this sub-site.

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Random Items

A cornucopia of things for you as I press my nose against the window of the world today. It's also only 7 days before the Games.

Olympic Games

Since I will be in Downtown Vancouver during the Games, I hope to bring you some streetshot photos of things going on outside the venues - no promises though.

Less than flattering news articles on the downtown eastside continue. Here's one from the Globe and Mail.

Meanwhile the lack of snow on Cypruss is fodder for the late night talk show circuit. I mean, honestly, anyone who lives here knows that it's no great surprise there is no snow locally in February. Why on earth isn't every alpine event up at Whistler?

A sports segment on ESPN shared that sentiment when talking about Cypress Mountain. The host of the segment said, "This isn't the big downhill mountain, this is some dopey little mountain where they're going to hold their little dopey X Games events."

Sigh. Too true.

Interest Rates

The people at the Council on Foreign Relations speculate that US interest rates on Treasury debt will be increasing around the end of the first quarter if the Fed discontinues its monetization of mortgage debt.

As the Fed has essentially purchased ALL new US Treasury issuance since 2009, that seems to be a reasonable bet (hattip: Jesse's Café Américain).

• "The Federal Reserve plans to stop buying securities issued by government housing loan agencies Fannie Mae and Freddie Mac by the end of the first quarter.
  
  This is not only likely to push up mortgage rates; Treasury rates should rise as well. Throughout 2009, the private sector sold a portion of their agency holdings to the Fed and used those funds to buy Treasury's.
  
  Once the Fed’s agency purchases stop, this private sector portfolio shift will end, removing a major source of demand in the Treasury market.
  
  As the chart shows, since the start of 2009 the Fed has bought or financed the entire increase in Treasury issuance. As Fed purchases slow and Treasury issuance continues at a high level, interest rates will have to move up to attract new buyers."

PIIGS

Gold has plunged downward as the US dollar surges against the Euro yesterday and today.

Why is this happening? The big story is the sovereign debt concerns of the impolitely nicknamed PIIGS. The PIIGS are Portugal, Italy, Ireland, Greece and Spain.

Driving the flight to the US dollar is concerns focusing on debt to GDP percentage of these countries.

What's so truly bizarre, however, is that the United States stands directly in the middle of the PIGS nations on the debt to GDP percentage scale!

In the US, state after state is facing serious budget problems. The latest is Connecticut as this report notes. "The signs of economic distress are everywhere -- in our towns, our homes, our businesses and places of worship. Connecticut residents are paying attention, and elected state officials who ignore what they are telling us do so at their own peril. If we thought that passing a state budget was difficult last year, just wait. This year's three-month legislative session will be brutal."

So... if the argument against the PIGS is the debt to GDP percentage. The exact same argument would place the US dollar in a crisis position.

Not to hard to see what lies ahead here.

It's becoming a race to the bottom, which ultimately is what makes currency values what they are. Watch for similar arguments about the size of the debt to GDP ratio to soon batter the US dollar.

Froogle Scott Chronicles

The next two instalments of the Froogle Scott Chronicles are out over at VREAA.

Part 2: Up, Up, Up: Winning the Real Estate Lottery can be read here.

Part 3: Priced Out Forever? Vancouver Renters and Basement Suites can be read here.

That's it for now. Updates may or may not be added.

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