100 Basis Points to Armageddon

Jul 22, 2011

Paris, France

Yesterday, we thought we made a breakthrough. For a second, it seemed as if the clouds had lifted. We had an illusion of comprehension; we thought we saw clearly what was going on.

After a certain point, debt becomes toxic - for a household as well as for a nation. For a nation, Professors Reinhart and Rogoff put that 'point of no return' at 90% of GDP. Greece, Japan, and the US - all are beyond that point. America's gross debt is 100% of GDP. Greek has debt of 120% of GDP. And Japan is off the charts, at 229%.

Reinhart and Rogoff say that once you get past 90% your GDP growth declines by 1%. Sure enough, the US used to run at about 3% annual GDP growth. Now it is down around 2%. Greece, the last time we looked, would be lucky to get any growth at all this year. And Japan, the biggest debtor of all, is actually going backwards...with negative growth.

When you are in this situation, by the way...you can't "manage" it. You can't ignore it. You can't turn knobs or adjust levers to make the problem go away. And you can't grow your way out of it either...because the debt suppresses your growth.

All you can do is to get out of debt...as soon as possible. Default. Go broke. Chapter 11. Chapter 7. Turn your pockets inside out and your mouth down.

Let it be.

Borrowing more money to keep from admitting the truth is disastrous. Europe just proved it.

Word got out yesterday morning that Europe had solved its Greek debt problem. As predicted, the authorities cobbled together an odd boot. And now they use it to kick the can further down the road.

But the nice thing is this: it's now a smaller can. After resisting the inevitable for more than a year, the authorities are finally giving bondholders a 20% haircut. The New York Times:

The pact , negotiated in Brussels, is part of a rescue package of 109 billion euros, or $157 billion, for Greece, the most troubled economy in the euro zone. It will force many investors in Greek debt to accept some losses on their bonds.

The deal would also provide substantial debt relief for Ireland and Portugal. And by giving the main European rescue fund increased powers to assist countries that have not been bailed out - like Spain and Italy - leaders are betting that the program, described by some as a new Marshall Plan for Europe, will serve as a firebreak against the contagion that has threatened to engulf some of the region's largest economies.

Officials have long shunned proposals that would make banks and other creditors share some losses on Greek debt. But European leaders are taking the calculated risk that they can avoid spooking investors by expanding the aid package to include other troubled countries on Europe's periphery.
By afternoon, investors were buying heavily. They couldn't be bothered to read the fine print or think too deeply about what the bailout meant. All they knew was that the trouble was behind them.

The Dow rose 152 points. Oil went up too...close enough to $100 as to leave a smudge. And gold went down $9, closing at $1,587.

Gold seems ready for a rest. It's been marching uphill for the last 11 years. Time to sit down and have a drink, no?

The debt deal in Europe doesn't solve the problem. The can will be kicked again. But at least the 20% loss to bondholders reduces its size. It's now back to about where it was when the Euro geniuses first started to kick it down the road!

Naturally, reports of salvation in Europe turned attention to America's budget troubles.

"Hope for US debt deal," says the Financial Times headline.

In Washington, of course, the problem is a little different. It's the central government that needs to be saved - from itself.

And here we find a political movement the Daily Reckoning can stand...far...behind. Yes, we support that narrow fringe of the Tea Party, the tiny part of it not invited to share the cakes and sandwiches, the part that actually wants the US government to default.

Whoa! We know what you're thinking. A default would be dangerous. Suicidal. Unthinkable. Ben Bernanke. Tim Geithner. Larry Summers. They all said so! The old folks wouldn't get their medicine. The soldiers wouldn't get their ammunition. Tops would go back onto honey pots all over the Washington DC area. The whole system would fall into anarchy and pandemonium. There would be riots. Revolution. Bourbon would disappear from the liquor store shelves. The dead would rise from their graves and the living would fall into the open holes. A man would be happy to see his dead wife alive again. Another would be even happier to see his living wife dead!

Well, maybe they're right. It would probably be a catastrophe. A disaster. But let's take the chance anyway!

Because the real problem is debt. The quicker it is eliminated...the faster the economy can get back to work.

So, don't raise the debt ceiling. Let the feds figure out how to get by like everyone else - spending nor more than they take in as income. Is that really so tough? ----------------------------------------------- Your Vote Matters! -----------------------------------------------

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*** "What do we have to talk about?"

Your editor was curious. He and his wife had gone down to the country. They found themselves - for the first time in their lives - alone together, in a big, quiet house.

For more than a quarter of a century, they have known little quiet. Their dinner table, for example, was always animated by young voices. One needed a new pair of tennis shoes. Another was mad because he thought he should not have to wash the dishes. One was late to dinner...another was early to leave.

The parents' conversation was always dominated by the children's' concerns.

"Stop squabbling and set the table," Pater Familias might be heard to say.

"Don't forget to do your German homework tonight," Mater Familias might add.

"Yes, we're going to church tomorrow." "No, you can't invite a friend for the weekend." "Maybe I'll get you a new pair of skates." "No, I didn't give your brother a bigger piece of cake than you got."

A dinner was never a calm affair. Too many little squirmy bodies at the table. Too many complaints. Too many unsettled arguments and too much unresolved, teenaged angst.

So, the parents might have sighed at least once or twice over the past 25 years and longed for the day when the children had left.

Then, the day came. Last Saturday. Edward, having graduated from high school, went on a trip with friends.

"I mean," Elizabeth continued, "now there are only two of us. What are we going to talk about?

"This is a big change in our lives. Now, we have to talk to one another. I guess we find out what each other has been thinking. Maybe we find out how we've changed.

"Until now, our lives and our attention have been focused mostly on the children. They needed a lot of attention and we can't regret it.

"I suppose that is why we know so many couples who split up after the children leave. When they are raising children they feel like they have a job to do, together. They may not always agree, but they can't deny there is work to do. And so they do it, keeping their heads down...focusing on the project they share.

"Then, when the children are no longer there, who is there to talk to? The work is over...or at least, the immediate, urgent part of it. What do they say to one another? Now, they look up and see someone across the table. Someone who is older than the person they married. And different. And I guess, many times, they find that they have little in common...or don't enjoy each other's company."

"Honey, I like your company..." said the husband.

"Yes, and I like yours," said the wife, picking up the newspaper.


Is there a fender anywhere in Christendom that the financial authorities have not dented yet?

They are lost without a compass. They are up the river without a paddle. At the automatic teller without a pin number. They have no theory that has not been discredited. They have no experience which does not contradict them.

In 2006, they couldn't see the crisis coming. In 2008, they couldn't understand it. In 2009-2011, they couldn't fix it. Their theory told them they couldn't spot a bubble; it was obvious to just about everyone else. Even here on the back page, we warned readers. Then, the financial elite mistook the problem for a lack of ready cash. Practically every American household knew what the real problem was: too much debt. And then, while everyone else knows you can't fix a problem of too much debt by adding more debt, the authorities missed the point entirely. Since they began applying their fixes, the national debt of Italy grew $360 billion. Japan's national debt rose $1.1 trillion. And the US added more than $2 trillion. They may have successfully 'kicked the can down the road'; but now it is a bigger can. Last week, they tripped on it again.

In these, the world's 3 leading debtors alone, the problem is now $3.5 trillion worse. And that is just a piece of it. These figures do not count the trillions' worth of other monetary and fiscal duct tape the feds have run through. Congressman Ron Paul put the figure for the US alone at $5 trillion and asked Mr. Bernanke about it.

What do you think you got for all that money, he wanted to know? The Fed chief remained true to his delusions. The money wasn't spent, he protested; it had been 'invested.'

Then, what was the return on investment? By every measure, the US economy is worse off than it was before the fixes began. After $7 trillion in losses, housing is still falling. The jobs picture is even worse. The broad "U6" unemployment rate - which includes those who have stopped looking for a job, part-time workers who can't get full-time jobs, etc - increased from 15.8% to 16.2% in June. The number of Americans with jobs fell by a quarter million to 153.4 million. And the time it takes to find a new job now exceeds the time in which the jobseeker typically stops looking - a record of 39.8 weeks. Hourly wages dropped. Hours worked fell too. And the portion of the population that is employed hit a new low of 58.2%.

While the proximate problem in America is at the household level, in Europe, it is in the banks, bailouts and boondoggles. Moody's, the giant rating company, tossed Irish debt into the junk yard last Wednesday, after already having knocked down Portuguese debt down the week before. Greek debt has had junk status for months; but Fitch downgraded it anyway; last week 10-year Greek notes were selling at 48% discount. Two year debt yielded 36% when we checked on Tuesday. Moody's said it was looking at US debt too; a downgrade is coming sooner or later.

The bigger the pile of debt gets, the more it stinks. Last week, investors began to notice a bad smell coming from Italy, the world's third largest debtor. The world's other two leading debtors - the US and Japan - have $26 trillion of sovereign debt between them. Add Italy and the total is nearly half the world's GDP. These are big numbers; they're not going away.

There is nothing especially deadbeat about Italy. At 120% of GDP its government debt is, officially, between that of the US and Japan. Unofficially, it is about even with the US. As for deficits, Italy is a model of integrity. Its deficit is only 4.5% of GDP, compared to America's 11%.

On these numbers you'd think that the cost of borrowing for one of these deadbeats should be about the same as for another. But recently investors decided that Italian debt could be as fatal as Spanish cucumbers. They sold it. Doing so, they sent yields on 10-year Italian bonds over 6%. Spain pierced the 6% level soon after. Since 7% is viewed as the upward practical limit - this brought all of Europe to only 100 basis points from Armageddon.

The authorities looked on like housecats watching the evening financial news. They saw the images. They heard the words. They had no idea. In Europe, they rushed to put together another bailout.

In America, meanwhile, the day of reckoning approaches too. In two weeks, unless the statutory limit is raised, America will cease making debt payments. It will be "worse than the Lehman bankruptcy," says former US Treasury Secretary Larry Summers. Armageddon, in other words. But in light of what their fixes have wrought so far, Armageddon is looking better and better.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

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