European Debt – Who’s Going to Pay?

What’s happening to 2011? It’s disappearing...
…but something tells me European debt will be here a little while longer.

Yesterday was warm and sunny in this part of the world. Today, it is raining and gloomy.

This is All Saints day. After the mass, we’ll go over to the cemetery to put chrysanthemums on a family grave. Why chrysanthemums? We don’t know. But everyone does it. The graveyard will be as busy as a subway station today.

Investors seem to have turned gloomy too. The Dow lost 276 points yesterday. Gold fell $22.

What’s behind it? Maybe this had something to do with it. From the Telegraph:

China has stressed it will not be a “saviour” to Europe as President Hu Jintao embarks on an official visit to the continent that will take in this Thursday’s crucial G20 summit in Cannes.

The warning came as European Commission President Jose Manuel Barroso and European Council President Herman Van Rompuy urged G20 leaders to use the meeting of major economies to address Europe’s debt crisis, saying measures proposed last week were not enough by themselves.

French President Nicolas Sarkozy has said Beijing had a “major role to play” in proposals to expand the European Financial Stability Facility (EFSF) to €1 trillion (£877bn), possibly through a special purpose investment vehicle that would attract backing from sovereign wealth funds.

The head of the bail-out fund, Klaus Regling, was despatched to Beijing to discuss terms, but travelled on to Japan at the weekend without an agreement.

China, holder of the world’s largest foreign exchange reserves at $3.2 trillion, said it wanted more clarity before investing.

The official Xinhua news agency, used to communicate Communist Party policy, said Europe must address its own financial woes. “China can neither take up the role as a saviour to the Europeans, nor provide a ‘cure’ for the European malaise,” it stated. “Obviously, it is up to European countries themselves to tackle their financial problems.”

Darned. Maybe the European rescue is not quite the done deal they thought it was. Europe’s heads of state said they would begin to commence to start putting together a plan to sort out the debt mess. That’s not the same as actually sorting it out. And it leaves out the essential bit of information — who’s going to pay?

You’ll notice that Europe’s envoy also paid a visit on the Japanese. That’s where this story becomes clear...and funny. Asking Japan for a loan is like asking a starving man for a piece of chocolate cake. Japan already has more government debt than anyone. Its public debt- to-GDP ratio is up to 230%.

Meanwhile, pressure is mounting on poor Silvio Berlusconi. Forget the Bunga-Bunga parties. Forget the underage prostitutes. Silvio’s problem is in the bond market, where yields on the 10-year note rose to 6.1% yesterday.

Almost all the developed nations have so much debt they can’t think about paying it back. They only worry about keeping up with the interest and refinancing costs. Japan only gets away with its debt burden because inflation and interest rates are both zero. It doesn’t cost anything to carry the debt.

But imagine that you have debt of 230% of GDP...and imagine that you have 6% interest. You can do the math. You’re paying 14% of GDP...just to keep up with the interest payments on money you spent years ago. In the US, that would be more than 30% of the entire federal budget. It would be 2/3rds of all tax revenues. It would be a disaster, in other words....

..it would also not happen. Because bond investors aren’t stupid. They would see immediately that they weren’t going to get their money back. They would sell bonds...forcing up interest rates even higher...and causing a meltdown of the whole system.

That’s the thing about debt. Somebody always pays. If not the debtor, as planned, then the creditor must pay. Or the taxpayer.

Debt never disappears. It represents resources that have been borrowed from the future. And the future never forgets. The future is a Shylock...always demanding its pound of flesh at the most inconvenient moment.

Here in France, there was a skit on TV that made its way to YouTube. It shows a cartoon character who looks for all the world like Barack Obama going up to an ATM machine. He puts in his card. But he finds he cannot get any money.

So, he goes to the Bank of China to get a loan. The Chinese banker, who bears a remarkable resemblance to China’s premier Hu Jintao makes the loan. But the Chinese want their pound of flesh too. In the next scene, Obama and French president Nicolas Sarkozy are both carrying a dragon in a Chinese New Year’s parade.

And yet, China has more than $3 trillion in savings. It is the rising star...the young, growing power. Like the US in the early 20th century, it is the nation to which the tired, old countries of the developed world look to finance their mistakes.

America financed Britain and France in WWI. But it did so for good reason — the money it lent was largely used to buy supplies from the US. Same thing in WWII. Lending money was a good business decision. After the wars were over, the US wanted its pound of flesh too. Trouble was, the debtors didn’t have a pound left.

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