Monday, March 8, 2010


The swirling economic ill winds continue to blow strong in Europe and we ignore what is going on at our own peril.

Tiny Iceland has used a referendum to express their outrage at being asked to take on the obligations of bankers who allowed the island’s financial system to create a debt burden more than 10 times the size of the economy. The populace is refusing to allow it's government to compensate the UK and the Netherlands for depositor losses stemming from the collapse of Landsbanki Islands hf (Icelandic internet bank) more than a year ago.

Meanwhile, despite some help from abroad and some attempts at internal reform, investors are still leery of Greece. Today, Greek ten-year bonds sell at yields north of 6%, nearly 300 basis points higher than similar maturities in German, Danish, or French sovereign bonds.

Next on that scrutiny list will be the United Kingdom.

With a debt ratio rapidly approaching Greek levels, the pound sterling has lost about 25% of its value even against the US dollar. The massive debt and misspending of the past three administrations, has led to serious out-flows from sterling and UK government ‘gilt-edged’ bonds, or ‘Gilts.’

The previously unthinkable notion of a British default has crossed into the realm of possibility. As a result ten-year British Gilts are selling off to yield above 4%, a significant premium above the country’s Continental rivals.

In other words, the free market has priced in a loss of the UK’s prized ‘triple A’ credit rating, even though the rating agencies have only issued warnings.

There is a shift now occurring in the great economic crisis of 2008 - 2010.

The first wave caused individual people and companies to face bankruptcy. The looming second wave threatens entire governments.

And it is one thing for prudent, rich states like Germany to bail out small states like Greece. But few states have the ability or the will to bail out financial giants like the UK.

The IMF is a sort of ‘central bank of central banks,’ but it is largely backstopped by the United States. Will China, Germany, or other creditor states be willing to assume the role of global guarantor?

And what of the United States?

Although the Federal Reserve is actively holding down the short end of the yield curve to near zero, 10-year notes are currently yielding more than 3.6%. If the Fed were to cease purchasing Treasuries, or the rating agencies were to become realistic, the free market would drive the 10-year rate into dangerous territory.

In Britain the free market is driving up rates despite the fact the rating agencies have not acted yet.

As I have said before, economic conditions all but guarantee the return of sky high interest rates. It's coming, just look around at world economic conditions.

It is as inevitable as the fate of this mouse...


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1 comment:

  1. As always excellent comments about the economic trends.
    And this one has a bonus - the accompanying photo of the White Owl in action, congrats!