The Likelihood of a US Default

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After 6 straight weeks of losses, it looks like the US stock market is ready for a winning week. The Dow rose 123 points. Oil stayed below $100. But the yield on the 10-year T-note rose above 300 basis points.

And here’s the latest from The Financial Times:

“S&P cuts Greece’s rating one step closer to default.”

Want to earn a nice yield on your money? Buy a Greek 10-year bond. It will pay you 17% interest. For a while.

But wait. You say you can’t trust the Greeks? You say they’re not good for the money?

“The Greek political landscape is ingrained with vested interests, endemic kleptocracy and bribery,” writes John Sfakianakis, chief economist of Banque Saudi Fransi.

Unemployment is around 20%. People dodge taxes. Government workers don’t show up for work. Households spend too much. And the government is going into debt so deeply and so rapidly it can’t possibly get out.

Hey… It’s just like the US! No, the US is worse, says Bill Gross. CNBC:

When adding in all of the money owed to cover future liabilities in entitlement programs the US is actually in worse financial shape than Greece and other debt-laden European countries, Pimco’s Bill Gross told CNBC Monday. Much of the public focus is on the nation’s public debt, which is $14.3 trillion. But that doesn’t include money guaranteed for Medicare, Medicaid and Social Security, which comes to close to $50 trillion, according to government figures.

The government also is on the hook for other debts such as the programs related to the bailout of the financial system following the crisis of 2008 and 2009, government figures show.

Taken together, Gross puts the total at “nearly $100 trillion,” that while perhaps a bit on the high side, places the country in a highly unenviable fiscal position that he said won’t find a solution overnight.

“To think that we can reduce that within the space of a year or two is not a realistic assumption,” Gross said in a live interview. “That’s much more than Greece, that’s much more than almost any other developed country. We’ve got a problem and we have to get after it quickly.”

How do you like that? He didn’t even mention the fact that Americans can’t sell their houses to Germans or turn their country into a retirement home for sun-deprived Scandinavians.

But wait, if the US debt situation is as bad or worse than Greece’s, how come the yield on US 10-year notes isn’t 17% too?

Therein may lay an even bigger opportunity. What if Mr. Market were making a mistake?

Everybody knows that Greece always defaults on its debt. It’s been in default, one way or another, for about half of its life – ever since it gained independence in 1828.

But the USA? If you can’t trust the US to pay up, who can you trust?

So, investors may feel secure lending money to the US…even though the fundamentals are little different from those of Greece. They may think: “the US never defaults.”

And yet, if there’s one thing we can learn from financial history it is that nobody is immune from financial errors. Everyone gets greedy and stupid from time to time. And no paper currency lives forever.

Right now, you can earn 17% on Greek debt or 3% or US debt. We’ll make a prediction that you can take to the bank: that spread will narrow.

The inflation rate in America is a matter of debate. But even the US government’s own number crunchers put it at about 5% for the first quarter of this year. That makes the real return on US 10-year notes a MINUS 2%.

How long will investors content themselves with a negative return? Maybe for a while. But not forever. They usually want a real return of about 3%, with no threat of default. A safe return, in other words.

And when they realize that the inflation rate in the US is really 5%…and that the return on US debt is NOT safe…they’re going to want a higher interest yield.

Say 5%. Or 7%. Or 10%.

Then, all hell is going to break loose.

Regards,

Bill Bonner
For 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.
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Comments

  1. What would happen to the price of gold if inflationary expectations rise and yields on US treasuries ratchet up into the mid-teens a.k.a the early 1980’s? Do you think that gold will hold its value or could the average investor be tempted away by the propspect of a 15% nominal interest rate vis-a-vis the negative rate of return implied by storage and security costs that gold offers? I hope you have forewatned all the mom and pop investors that have rushed into paper gold i.e. ETFs in a bid to hide from the Fed’s printing press and from the scare-mongering and hell, fire and damnation propaganda. The great irony of it all is that there actually still is something more worthless than paper money – its called paper gold!

    Truth Serum
    June 18, 2011
    Reply

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