European Sovereign Debt Crisis Set to Spread … Government Bonds at Risk!

According to its homepage, the Bank for International Settlements (BIS) is an organization that fosters international monetary and financial cooperation and serves as a bank for central banks.

The BIS fulfils this mandate by acting as:

• A forum to promote discussion and policy analysis among central banks and within the international financial community,

• A center for economic and monetary research,

• A prime counterparty for central banks in their financial transactions, and

• An agent or trustee in connection with international financial operations.

In short, the BIS is the central bank of central banks. So if you want to know what’s on the mind of the international central banking community, the BIS is the right place to start. Indeed, an organization you should regularly follow.

Sometimes BIS economists point out problems certain central bankers refuse to acknowledge, or they’ll come to conclusions some members of the central banking tribe would rather refute.

And on Sunday, December 12, that’s exactly what happened when the BIS reported that …

Foreign Exposure to PIGS Debt
Is a Major Threat

The BIS’s latest quarterly review contains a tabulation of exposure, broken down by nationality, to debt of the four most problematic countries: Portugal, Ireland, Greece, and Spain.

Major industrial countries are over exposed to PIGS.

The grand total: A staggering $2.2 trillion! Nearly one quarter — $513 billion — is held by German investors. U.S. investors are on the hook for $353 billion and U.K. investors for $370 billion.

These are humongous numbers.

Conservatively speaking, these debts will need at least a 30 percent haircut for the PIGS to have a realistic opportunity of getting out of the hole they’re in. And if that 30 percent is the result of defaults, the international banking system would again be severely wounded.

That’s why I called the Greek bailout earlier this year another banking system bailout. And that’s why the international community claims bailouts are the best choice.

There is always an alternative. But in this case, the political will is obviously lacking. So as analysts and investors we have to accept it as a reality and ask ourselves where this may lead.

The Difference between a Liquidity Crisis
and a Solvency Crisis

I have always made the case that the political reaction to the housing and banking crisis of 2007-2009 was not solving, nor addressing, the underlying problem of too much debt. By adding more debt you can buy some time and kick the can. But in doing so the problem only gets bigger, which is what has happened.

Back then we had banks and other corporations on the brink of collapse. Now many countries are in the same boat!

To understand what was going wrong then and what is going wrong now you have to distinguish between a liquidity crisis and a solvency crisis …

A liquidity crisis is a temporary inability to pay. The debtor is sound enough to service the debt. In such a case you might have a good reason for a bailout.

A solvency crisis is a different story …

The debtor does not have the wherewithal to service the debt. Therefore, additional credit can only aggravate the situation — it’s throwing good money after bad.

The Government Debt Crises
Are Solvency Crises

The current government debt crises are clearly solvency crises. And many governments will finally have to acknowledge that their debt mountains are too large to service.

Bailouts do not improve the situation of these countries. Nor do they help the countries making bailouts. In fact, they too are up to their eyeballs in debt.

Stronger countries are seeing their debts mount.

That’s true for Germany, that’s true for Japan, that’s true for the U.K., and that’s true for the U.S.

The longer these relatively stronger countries finance the weaker ones — either directly or via international organizations like the IMF — the faster they’ll face ruin themselves. At the same time, they’re almost guaranteeing that the sovereign debt crisis will spread like wildfire.

What does this mean for you?

Well, scores of government bonds, once considered safe investments, aren’t safe anymore! That’s because investors now realize that many industrial countries will sooner or later have to make a tough choice: Either outright default or surging inflation.

Best wishes,

Claus

P.S. I have just released my new book, The Global Debt Trap: How to Escape the Danger and Build a Fortune, which I think is timed perfectly for the events now swirling around us.

For the complete foreword of The Global Debt Trap by Martin D. Weiss, click here. For more on the authors, click here.