Sovereign Debt: a Threat to the Entire Financial System


“Ireland is broke,” said our taxi driver.

We like to ask cab drivers about the economy. Not that they understand anything any better than the average central bank economist. But they talk to people. Without cameras or tape recorders in the background. And they have their own businesses too. When times are good, people take cabs. When they are bad, they take the bus.

“My bloody income is down by 50%. Most of my fares are people coming or going on business…or just people going to work. But now, who’s doing business? Who’s working?

“The developers and the bankers ruined this country. They pushed up prices. And then, what was the government doing? They haven’t a clue. The guy who is head of Ireland’s financial affairs is a former schoolteacher. I’ve got nothing against schoolteachers, but what does he know of finance? And he’s over there negotiating with the Germans.

“The Germans know what they’re doing. They don’t want to finance our mistakes. And who can blame them?”

In many ways, the Great Correction is hitting Ireland harder than the USA. If the US overbuilt, Ireland overbuilt even more. If the US over- borrowed, Ireland borrowed even more. And if the USA got lost in debt finance, Ireland got lost in dreamland.

“We are dreamers, I guess. And storytellers. It’s a status thing in Ireland. You go into a bar. Look for the fellow who has the most people gathered around him. He’s the big man locally. Not the doctor. Not the politician. Not the rich man.

“We’re dreamers and storytellers…and then, we come to believe our own stories. ”

The Irish dream big. The republic is not big enough for them. So they go abroad. Only 4 million of them are left on the island. Some 60 million of their descendants – the Irish diaspora – live in America, Canada, Australia, Argentina and elsewhere. Your editor is one of them.

For the first time in more than a decade, the Irish are emigrating again.

“If you’re a smart young man or woman, what else can you do? It’s sad for their families. But Ireland has nothing to offer them. They have to leave. And usually, they don’t come back.”

Yesterday, we went to open an account at the Bank of Ireland.

“They must have been glad to see you,” said a colleague. “You must be the first person to open an account in years. The rest of us are taking our money out. Every bank in Ireland is insolvent, and everybody knows it.”

“Well, there was no line,” we replied.

Instead, we got to the bank door at 10AM. We rang the doorbell (the bank didn’t open until 10:30, but we had an appointment). A dignified older man in a sweater and a tie opened the heavy oak door.

We stated our business.

“Oh…yes… She’s waiting for you.”

In front of us was an attractive woman of about 30. Well dressed. Well coifed.

“Will I lose my money if the bank goes broke?” I asked.

“Ha ha… There’s no chance of that,” said the woman with a look of earnest intensity that you usually associate with time-share salesmen and insane people. “I guess you would say that we’re already broke, technically. But we have a deal with the European Central Bank. We have a line of credit. We won’t default. And even if we did, your money is protected by an Irish government scheme that protects depositors up to 100,000 euros.”

“Well, isn’t the Irish government insolvent too?”

“Ha ha… Well, I suppose that it is too. Technically. But so is your American government, isn’t it? But this is just a technicality. The whole system is not going to go broke. We’re supported by Europe. And Europe does not want to see Ireland default.”

She was right about that. Europe does not want to see Ireland default. Because the debts of Ireland are the credits of French and German banks. If Ireland were allowed to default, the whole kit and caboodle could come apart.

Ireland can’t borrow on the open market. Lenders are not idiots. So the Micks and Paddies borrow from the European financial authorities. The low rates keep Irish households above water. Most mortgages here are “floating rate” loans. If the rates were allowed to float up to market levels, Irish households, banks, and the government itself, would all sink.

For the moment, Europe lends at low interest rates to the Irish…who keep their banks and voters from going bust. The banks, in turn, keep their creditors from going bust. And so the whole system, in Europe as in America and Japan, depends on a continued flow of artificially cheap money

And everyone seems to think this flow of cheap money can continue indefinitely.

Welcome to the modern political economy… Small, isolated problems are rolled up into bigger and bigger ones. Soon, the danger is not to a bank…or even to a nation…but to the entire system.

We don’t know when it will stop. Nor do we know exactly what will make it stop. But we’re sure there’s money to be made betting on it.

And more thoughts…

And now, let’s update our Trade of the Decade.

Our “Trade of the Decade” called for selling Japanese bonds and buying Japanese stocks. The bonds go down when the liquor runs out…and then, when Japan can no longer close its budget gaps by borrowing, it will print money. First, the bonds will crash. Then, the stocks will soar.

Has it done well? Not exactly. But the decade has just become. And it looks more promising than ever.

Lord Keynes may not have had the Japanese bond market in mind. But almost an entire generation of JGB investors is living proof that “the market can stay irrational longer than you can stay solvent.” For nearly 20 years, they thought rising supplies of Japanese bonds must lead to falling prices. As the quantity increased the quality had to decline. It was irrational to think anything else. And yet, Mr. Market not only remained irrational, he seemed to enjoy it. He was like a drunk with a half-finished bottle in his hand. Everyone knew he would have to sober up some day. But as long as there was still liquor left, why bother? Japan borrowed more and more…and speculators went broke waiting for bonds to go down.

Here on the back page we yield to no man in our appreciation of the irrational. It is practically boundless, as near as we can tell. Nevertheless, sooner or later the booze runs out.

What makes this interesting to readers everywhere is that Japan is a trendsetter. The Japanese stock market headed down 10 years before the NASDAQ cracked in the US in January of 2000. Japan’s economy was ahead of the pack too; it went into a long correction 17 years before America’s subprime lending crisis. Its central bankers and finance ministers have a long lead too. Every rabbit, currently being pulled out of Ben Bernanke’s hat, was hopping around in Tokyo many years ago.

For example, the Japanese have been “zero bound” for 15 years. In an effort to restart the economy, the Bank of Japan went to ZIRP (a zero interest rate policy) in 1995. They’ve been within 50 basis points of zero ever since. So too did Japan’s huge central government deficits begin a decade ahead of those in the US. But the rope that was thrown out as a lifeline has become a noose. Japan can’t go back to normal policies; it can’t afford it.

Among all the world’s nations none now has more debt per GDP than Japan. For every dollar of output, Japan has $2 of central government debt. The figures are much more striking, and meaningful, when you compare debt to the cash-flow that services it. The central government owes about 1,000 trillion yen. It collects less than 50 trillion in revenues each year. In other words, every dollar of tax receipts must support about $20 in debt. If it had to carry its debt at just 5% interest it would take up 100% of government revenues. And its debt is still increasing; the Bank for International Settlement says it will grow to 3 times GDP over the next 10 years.

Pondering these numbers, JGB speculators must have thought they had found a gold mine. Japanese bonds HAD to go down, they said to themselves. What they discovered was that a government can stay insolvent longer than they could stay rational. And now, practically every financial official, householder and investor on the home island is foaming at the mouth. Having avoided sanity for so long, they think they can do so forever.

The descent into insolvency was directed by the Bank of Japan and enabled by bond buyers themselves. It did not bother them that Japan was the most broke nation in the world. Or that the Japanese were dying out, with negative population growth and more people retiring than entering the workforce. Or that the primary sources of funding for Japanese deficits were drying up. Corporate profits are pinched between the forefinger of a strong yen and the thumb of higher energy prices. The savings rate for people over 60 has fallen to zero. And as a percentage of GDP, national savings, net of both public and private borrowing, has fallen from plus 11% in 1991 to minus 5% today.

Lenders must be as stupid or as mad as borrowers. Even today, they give their money to the government for 10 years, at a yield of only 1.2%. But so far, they have been right. The inflation rate in Japan is negative by about 2%, giving them a real yield of 3.5%. And compared to other investors in Japan, bond-buyers are geniuses. Japanese stocks are down 75% since 1990. Real estate is down about 70%.

He should get out more. Take a trip to Japan. He would see where $1.5 trillion deficits, ZIRP, and QE lead – to more deficits, more ZIRP, and QE squared. He would see the madness in investors’ eyes…and palsied hands of his central banker cronies. They couldn’t stop. Neither can he. Not without higher unemployment and falling prices – the very things he fears more than the fires of Hell. Once an economy drinks deeply, it cannot stop until the bottle is empty.


Bill Bonner
for The Daily Reckoning Australia

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
Bill Bonner

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1 Comment on "Sovereign Debt: a Threat to the Entire Financial System"

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Richo (the Second)
Richo (the Second)
5 years 7 months ago

although perhaps avoid buying Japanese car stocks (Toyota, Honda, Suzuki, Subaru) if there is a pending global recession as no-one will buy new cars – particularly in the US. Mental note to avoid buying whaling meat stocks given the hunt in the southern ocean was unsustainable (a quite hooray there!). Maybe avoid Japanese technology stocks as China is producing better better quality and cheaper electronics. Is there such a thing as a Japanese mining stock?

Yep – buy Japanese stocks.

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