Savings and Loan Bailout

January 10, 2010

As the world enters 2010, what lies in store for the citizens of the world?  Could even bigger bank bailouts coupled with government defaults lie just below the horizon?  What happens if a medium or large size, first World County defaults on their debt?  Does the failure of a small economy country create a domino effect for the global economy?  These questions and more may get answered this year, whether consumers like it or not.

For readers, let's take a hypothetical journey down "what if" road.  The scenario that will be covered is a debt default of a medium size country; say the size of Spain or the United Kingdom.  In order to describe the actual default of one of these countries, it’s important to lay out the probable warning signs that leads up to the default before discussing the actual default and the potential consequences for that country as well as others around the world.

ECONOMIC DATA

Before beginning, readers need to orient themselves with a couple of critical statistics and formulas.  These have all been gleaned from publicly available data found at Wikipedia, the IMF and Bloomberg.

·         Estimated Worldwide GDP 2008 in Dollars:  $60.92 Trillion

·         Worldwide Exports in Dollars: $16.28 Trillion

·         Worldwide Imports in Dollars: $16.21 Trillion

·         US 30 Year Treasury Yield (1/8/10):   4.72%

·         US 10 Year Treasury Yield (1/8/10):  3.83%

·         US 5 Year Treasury Yield (1/8/10):  2.59%

·         US 2 Year Treasury Yield (1/8/10):0.98%

·         US 1 Year Treasury Yield (1/8/10): 0.33%

·         US 6 Month Treasury Yield (1/8/10): 0.15%

·         US 3 Month Treasury Yield (1/8/10): 0.04%

In addition, at the end of this article is a detailed listing of the top twenty countries by external debt to GDP.   

According to both the World Bank and well as the International Monetary Fund (IMF), sustainable debt limits are the lower of 150% of exports or 250% of a country’s revenue (not GDP).  Here is how the IMF specifically describes it: http://www.imf.org/external/pubs/ft/eds/Eng/Guide/file6.pdf

IMPACT OF APPROACHING & EXCEEDING SUSTAINABLE DEBT LEVELS

Those countries that have an unsustainable debt burden experience several impacts.  Impacts include the following:

·         Crowding out of private sector debt (business and consumer)

·         Higher nominal interest rates

·         Higher tax burden on consumers and businesses

·         Increasingly higher interest rates

·         Falling home currency values

·         Shortening of debt maturities

·         Increasing possibility of a wholesale debt issuance lock-out by the market and creditors

Ultimately, a country defaults on their debt obligations, devalues their currency, or both.  The most recent example is Iceland.  Iceland recently devalued their currency and now risks a default of their debt.  This comes as a result of the recently executed veto of the “IceSave” bill.

Earlier this week, Venezuela became the latest country to devalue or default.  Venezuela devalued their currency by up to 50% (depending on the type of good or service).  Inflation was already running at a 25% annual rate before the devaluation occurred.   Unfortunately, Iceland and Venezuela as well as others including North Korea and Dubai, are just the tip of the iceberg, so to speak. 

Based on rapidly deteriorating debt fundamentals, other countries are quickly racing to such a nightmare situation. Each of their defaults and devaluations increases the risk of the same happening to the United States.  How is it possible that the United States could default on their debt or devalue its currency?  Even though the US has a smaller debt-to-GDP ratio of Iceland, Ireland and others, it still has the largest absolute debt in the world.  As the world reaches ever closer toward its maximum sustainable debt carrying capacity, all debtors face the potential of debt-market lock-out.  It is brought on as a result of global saturation of debt.

UNSUSTAINABLE GLOBAL DEBT LEVELS

Adding up the total debt of just the top twenty countries with the largest debt- to-GDP ratio, one arrives at a total debt among them of roughly $50.7 Trillion or 83.2% of worldwide GDP.  Assuming global country revenues (taxes) are at 25% of GDP (the U.S. had a 2008 ratio of 18.7% -- 2008 Revenue of $2.66 Trillion / 2008 GDP of $14.26 Trillion), that would equate to a global debt to country ratio of 332.9%.  The number sounds pretty unsustainable.  The world has just failed the IMF’s first sustainability test.  What about the export test?

On a debt to exports basis, the situation is just as bad.  That ratio comes out to 311.6% of global exports. 

No matter how it is sliced or analyzed, the global economy is not on a sustainable basis.  Even if the effective global tax rate spiked up to nearly one in two dollars (40% tax rate) allocated to government revenues, it would be over 200%...still near the limit of sustainability. 

What is more worrisome is that the debt of EVERY OTHER COUNTRY outside of the top twenty was not included in the above calculations.  Adding them would make it even direr.  As important, most of the data is at least 6 months old, and in most cases at least a year old.  As everyone knows, the past year only served to magnify the gruesome nature of the data.   

Even if one assumes the IMF’s prediction of worldwide GDP growth clocking in at 3.1% in 2010, it is insignificant compared to the planned new debt issuance from countries around the world.

FOLLOW THIS LINK TO READ PART II

(Reference: http://www.cnbc.com/id/30308959?slide=1)

Ireland External debt (as % of GDP): 1,267%
Gross external debt: $2.386 trillion (2009 Q2)
2008 GDP (est.): $188.4 billion

Switzerland External debt (as % of GDP): 422.7%
Gross external debt: $1.338 trillion (2009 Q2)
2008 GDP (est.): $316.7 billion

United Kingdom External debt (as % of GDP): 408.3%
Gross external debt: $9.087 trillion (2009 Q2)
2008 GDP (est.): $2.226 trillion

Netherlands External debt (as % of GDP): 365%
Gross external debt: $2.452 trillion (2009 Q2)
2008 GDP (est.): $672 billion

Belgium External debt (as % of GDP): 320.2%
Gross external debt: $1.246 trillion (2009 Q1)
2008 GDP (est.): $389 billion

Denmark External debt (as % of GDP): 298.3%
Gross external debt: $607.38 billion (2009 Q2)
2008 GDP (est.): $203.6 billion

Austria External debt (as % of GDP): 252.6%

Gross external debt: $832.42 billion (2009 Q2)
2008 GDP (est.): $329.5 billion

France External debt (as % of GDP): 236%
Gross external debt: $5.021 trillion (2009 Q2)
2008 GDP (est.): $2.128 trillion

Portugal External debt (as % of GDP): 214.4%
Gross external debt: $507 billion (2009 Q2)
2008 GDP (est.): $236.5 billion

Hong Kong External debt (as % of GDP): 205.8%
Gross external debt: $631.13 billion (2009 Q2)
2008 GDP (est.): $306.6 billion

Norway External debt (as % of GDP): 199%
Gross external debt: $548.1 billion (2009 Q2)
2008 GDP (est.): $275.4 billion

Sweden External debt (as % of GDP): 194.3%
Gross external debt: $669.1 billion (2009 Q2)
2008 GDP (est.): $344.3 billion

Finland External debt (as % of GDP): 188.5%
Gross external debt: $364.85 billion (2009 Q2)
2008 GDP (est.): $193.5 billion

Germany External debt (as % of GDP): 178.5%
Gross external debt: $5.208 trillion (2009 Q2)
2008 GDP (est.): $2.918 trillion

Spain External debt (as % of GDP): 171.7%
Gross external debt: $2.409 trillion (2009 Q2)
2008 GDP (est.): $1.403 trillion

Greece External debt (as % of GDP): 161.1%
Gross external debt: $552.8 billion (2009 Q2)
2008 GDP (est.): $343 billion

Italy External debt (as % of GDP): 126.7%
Gross external debt: $2.310 trillion (2009 Q1)
2008 GDP (est.): $ 1.823 trillion

Australia External debt (as % of GDP): 111.3%
Gross external debt: $891.26 billion (2009 Q2)
2008 GDP (est.): $800.2 billion

Hungary External debt (as % of GDP): 105.7%
Gross external debt: $207.92 billion (2009 Q1)
2008 GDP (est.): $196.6 billion

United States External debt (as % of GDP): 94.3%
Gross external debt: $13.454 trillion (2009 Q2)
2008 GDP (est.): $14.26 trillion