May 18, 2012
Topics: Bond Vigilantes
The media has been talking about sovereign debt defaults nonstop. Greece is not able to make interest payments and Spain and Italy is not too far behind. The fact is that most countries in the developed world have lived above their means and run budget deficits for decades. As a consequence debts have been rising and many countries are quickly heading towards a point of no return; when interest rates become too high to handle. At this point the country will be forced with options of; defaulting on the debt, printing and inflating away the debt, or doing a little bit of both.
Many countries are in the danger zone of defaulting but there is no magic number or formula that determines when a country runs up against the wall. It is a confidence game and once the market loses confidence in the countryâs ability to pay its bills; interest rates quickly skyrockets.
Greece ran up against the wall when debt-to-gdp went to 125%, but this is by no means a benchmark. For example, Japan is currently able to maintain a debt-to-gdp of 233% while Russia defaulted on a debt-to-gdp of only 12% in 1998. The chart below shows at what level other countries have gotten into trouble before.
Chart â Countries that defaultedHowever, the reason so many countries in the developed world are able to maintain high debt loads is because they have been perceived as more credit worthy. Many of the countries in the developing world have lower debt-to-gdp ratios because no one has been willing to lend them money.
According to the Committee for a Responsible Federal Budget (CRFB), once a country reaches a debt-to-GDP ratio of 90%, interest payments quickly rise and impede the countryâs ability to grow and pay back debt.
Nevertheless, many places such as the United States, Japan, Germany, and Canada already have a debt-to-GDP ratio of 90% or higher and they have been able to finance their debt at extremely low interest rates.
It appears that the market and the bond vigilantes are hitting one country at the time â starting with the weakest. So while the US, Japan and many other developed countries have debt levels that are unsustainable they have been able to get away with it so far. But this cannot go on forever and a day of reckoning will eventually come. To quote Bill Bonner âSomething that cannot go forever, wonât!â
Right now the bond vigilantes are targeting the PIIGS in Europe but once their work is done over there they will look elsewhere. The chart below shows countries that are in the danger zone.
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