The Euro is still sliding today (down to about $1.22) and the news out of Germany and Europe is mixed. Greek bonds have bounced a bit, so that’s fine. Unfortunately, I’m seeing reports that Germany’s Finance Minister reportedly announced that the country will ban certain types of short selling. On the surface that may not seem like a big deal to many, but it is a classic move of governmental desperation. It does not work anyway and it suggests the German government is running out of options.
Here’s a chart of recent activity in the Euro. At some point, we should see a bounce, but this is still a very negative picture.
Source: Bespoke Investment Group
This report from MarketWatch.com amplifies a bit on the fears sweeping the bond, stock and currency markets right now:
…The debt mountain that brought down some of the world’s biggest banks and dragged the international financial system to the brink of disaster has simply shifted to governments. Now it’s threatening countries around the globe — and, if left unchecked, could rip the very fabric of Europe’s economic system and wreck economic recoveries in the U.S., China and Latin America.
The impact on markets has been severe. The euro has slumped more than 12% against the dollar since the sovereign-debt crisis flared in southern Europe. Gold has marched to new highs as investors seek a safe haven and, perhaps most alarming, it is now more expensive to buy insurance against national default than it is to insure against corporate failure…
I believe we are approaching the limits of sovereign debt here in America and in many countries abroad, including Greece, Japan, the UK and others. For example, Greece has a budget deficit north of 13% of GDP and there is little likelihood that the political and social will exists to cut that back in a meaningful way. Government debt amounts to 125% or more of GDP. Deficits and debt of that magnitude are well beyond what that economy can manage. In other words, Greece is broke.
The prescription for regaining fiscal health — reduced government spending, layoffs of government employees, spending discipline — would probably work, but would also trigger negative consequences including lower economic growth and social unrest.
Bailouts building up government debt
We have pointed this out before. Essentially, the bailouts we have participated in (TARP, Fannie Mae, Freddie Mac, state unemployment funds, Greece etc) over the past couple of years have helped stabilize the financial markets, but that burden of debt has just been shifted to our government and those of other nations.
Here is some additional — sobering — information on the increase in our national debt [emphasis added]:
Preliminary Analysis of the President’s Budget (Congressional Budget Office, Director’s Blog, Mar. 5, 2010, Douglas Elmendorf)
CBO's preliminary analysis (incorporating contributions from the staff of the Joint Committee on Taxation) indicates the following:
The CBO’s estimate that Federal debt held by the public will reach 90% of GDP is something that should concern us very much because debt at that level sharply reduces the flexibility the U.S. Treasury has to respond to future crises.
In their book, THIS TIME IS DIFFERENT (Eight Centuries of Financial Folly, Princeton University Press, 2009), Carmen Reinhart and Kenneth Rogoff make two critical points:
…If there is one common theme to the vast range of crises we consider in this book it is that excessive debt accumulation, whether it be by the government, banks, corporations, or consumers, often poses greater systemic risk that it seems during a boom…
…Although private debt certainly plays a key role in many crises, government debt is far more often the unifying problem across the wide range of financial crises we examine…
And, the number they peg as being very serious is debt at 90% of GDP. Once debt hits that level, a serious financial crisis is much harder to avoid. As you can see from the CBO report above, we are projected to hit that level or above — national debt of more than 90% of GDP — in less than a decade.
Instability in the financial markets is a big threat and I frequently agree with the interventions that have been done both here and in Europe. At the same time, we have to realize that there is a limit to what governments can undertake financially.
How sound is our balance sheet?
The financial soundness of our national balance sheet, and those of Greece, Germany, Japan and other countries, is of critical importance. Maintaining that soundness is all about keeping expenditures well below tax revenues in good times so that budget cutbacks don’t have to happen in recessions. Unfortunately, we the people, and our representatives seem to have forgotten that basic fact, at the local, state and national levels.
Now that we are out of the recession, we should be focused on ways to cut spending and debt, not increasing them. My gut feeling tells me that our fearless — about spending our money — leaders will not willingly do that though.
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Kurt Brouwer is a fee-only financial advisor with three decades of experience. He is the chairman and co-founder of Brouwer & Janachowski, LLC. Kurt has written books, articles and hundreds of blog posts on mutual funds, ETFs and other investment topics. E-mail: kurt.brouwer *at* gmail.com.
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