Flamenco Sketches
I’m sitting here listening to Miles Davis and pondering the future as the US financial markets close on a day where yields on the Spanish government’s ten year bond climbed above 7.6% and the yield on the US 10 year Treasury bond dropped briefly below 1.40% for the first time in history. Pondering the future is always sketchy, but it is important to nonetheless to watch these events and how they unfold on a day to day basis and their relevance to what more events are yet to come.
First let us deal with Spain and its debt laden government. During the middle part of last week the Spanish central government announced that it would be setting up an 18 billion euro fund to assist in solving any potential problems that regional governments may have in meeting their debt obligations. On Friday the government of Valencia announced that it would be tapping the fund because it could not pay its bills, and over the weekend the government of Murcia further down the Mediterranean coast followed suit. Suspicion began to grow in the bond markets that most, if not all, regional governments would go down this path, leaving the Spanish central government on the hook for all of their debt. This amounts to a grand total of something like 160 billion euros with 36 billion (http://economywatch.msnbc.msn.com/_news/2012/07/24/12931119-spain-teeters-on-the-edge-of-a-steep-fiscal-cliff?lite) needing to be refinanced before the end of this year. Could the Spanish government afford this?
The bond markets are betting that the answer is no. Yields have surged now to euro era records and money is fleeing toward safer havens such as the German bund (though this has abated with Moody’s downgrade of Germany’s outlook) and, despite everything, that safe haven of safe havens: the US ten year Treasury bond. Spain however needs financing, and needs it fast since its economy is locked in a depression and the central government’s fast dwindling tax revenues can’t even come close meeting the staggering new costs of assuming regional debt. So one month after a European fund was established to bailout Spanish banks with much hand wringing so that the funds would go (against strong German objections) straight to Spanish banks, bypassing the government so not to add to its debt, it appears that the Spanish government will need a bailout after all and in fairly short order.
After tortuous negotiations over the coming weeks and months I am almost certain that this bailout will be approved as it has been obvious for some time now that the scales will have to be ripped from the eyes of the European elites who make these decisions as to the profound foolishness of this policy. A bailout here only breeds a bailout there and so on. Soon massive amounts of debt which cannot possibly be paid back pile up with whatever central authority that dispensed these bailouts, and since these central authorities are usually responsible for the maintenance of law and order and stability over a wide geographical area, their insolvency represents a potential civilizational crisis.
The fundamental internal challenge that the Western world faces are as follows: a massive and unsustainable housing boom in the United States developed in response to the Federal Reserve’s irrational post dot.com bust/9-11 attack policy of keeping interest rates at near zero for the better part of a decade. Then when they attempted to raise rates again in 2007 it crushed the housing boom which put a knife into the heart of a banking system that had become by that point all too dependent on buying and selling other people’s mortgages to finance themselves. For obvious reasons governments could not allow their globally interconnected banking system to collapse, so they bailed them out and assumed massive amounts of debt themselves and now these chickens are all coming home to roost.
It started first in the smaller and weaker countries (Greece, Portugal, Ireland) as it always does. Now though it appears as though the government of the fourth largest economy in the eurozone will need to be put on life support with a bailout. And don’t think that it will stop there. If the EU somehow scrapes together the funds to get Spain temporarily out of the lurch, then the bond market will attack Italy next. There is not enough real wealth in Europe to sustain all of these massive bailouts.
Meanwhile incredible amounts of capital would flow to US Treasury bonds. It is conceivable that the yield on the 10 year could drop to zero in the event of a euro area breakdown. The hazard in this is that monumental amounts of productive capital will be tied up financing a government that already has too much debt to begin with. Economic activity will slow and capital will flow with greater speed toward the US government where it does little or nothing to promote economic growth, which would be the only way out of the conundrum we are sure to find ourselves in during the coming years. And at some point someone with a great deal of resources will realize that the United States government has acquired so much debt that there is no way it can ever be paid back, at least not in terms of real value, and will put their money into real assets or hide it in a very large mattress. If it gets that far then the jig will be up for Western Civilization.
