Although the crisis in America will probably come last because of our global status, at the end of the day we are still borrowing whatever we cannot raise in revenue. This makes us no different from Greece. We just announced the largest monthly budget deficit in history, which demonstrates that we still have not attacked the disease. We find ourselves in a very precarious position because it now takes about 4 years to match the national debt it took 224 years (until 2000) to accumulate.

The real serious debt problems are straight ahead. Under the Federal pension system (FERS), pensions are based on: 1) the average of your highest 3 years of pay, and 2) your years of service. A higher proportion of government employees happen to be in higher paid fields such as law. (As a side note, this is why the SEC is so damn incompetent- it is an agency filled with lawyers. Who thought up the genius idea of having lawyers with no experience in finance regulating financial markets? Our government is a lot stupider than you think). Anyway, since public sector workers are well-paid, their pensions will be very generous under the current system.

Now let’s think about the wave of people who are eligible to retire. In 2007, 18% of Federal employees were eligible to retire; by 2016, that number goes to over 60%. Hmm. Is a pension crisis perhaps on the horizon? Don’t worry, your leaders will tackle the crisis head on– in 2016 when it is too late.

This crisis is going to wipe out retirees if the correct actions aren’t taken. Stay the hell out of government bonds and buy stocks. The government only has one option- the printing press- and they are willing to use it. Bernanke has stated in previous papers that he would not raise interest rates to counteract an economic slowdown created by oil shocks. Instead he will inflate, inflate, inflate. This is the reality we face today.

But Stocks Are Rising!

The mainstream media basically has no clue what they are talking about. They are like little children who try to find any data points that corroborate their predetermined conclusions. Stocks are rising so the economy must be recovering. Never does it cross their mind that perhaps we are seeing the beginning stages of severe inflation. At the end of the day, I cannot blame them- their knowledge of history is very small. People always misinterpret the early stages of inflation as a boom. Just take the example of Frau Eisenmenger, an Austrian who lived through their hyperinflation in the 1920′s, who wrote:

“Speculation on the stock exchange has spread to all ranks of the population and shares rise like air balloons to limitless heights.”

Sound mildly similar to the situation we face today? Eisenmenger wrote this before things got really bad in Austria. People saw stocks as a hedge against inflation, especially because of the composition of stocks back then. If you look at the historical accounts, tangible assets were in demand, not government paper. The Weimar Republic actually had full employment while their economy was imploding. Consumer spending was robust because people were trading in paper they knew was being depreciated for real goods and services. If the mainstream media were analyzing conditions back then, surely they would be calling it a “green shoots” economic recovery. There is a reason the mainstream can never see a crisis coming- their analysis is very flawed.

This is not the time to go 100% short stocks just because you are bearish on the economy- there are other factors at play. Stocks will rise because the big money will be trading their government bonds for stocks. Want proof? Look no further than Bill Gross, manager of over $1 trillion at PIMCO, who says to stay out of government debt. Make no mistake about it, the smart money is getting the hell out of government bonds. You should be doing the same.

Source: Record Budget Deficits, Pensions Coming Due

By Bill Bonner

03/04/11 Waterford, Ireland – “Ireland is broke,” said our taxi driver.

We like to ask cab drivers about the economy. Not that they understand anything any better than the average central bank economist. But they talk to people. Without cameras or tape recorders in the background. And they have their own businesses too. When times are good, people take cabs. When they are bad, they take the bus.

“My bloody income is down by 50%. Most of my fares are people coming or going on business…or just people going to work. But now, who’s doing business? Who’s working?

“The developers and the bankers ruined this country. They pushed up prices. And then, what was the government doing? They haven’t a clue. The guy who is head of Ireland’s financial affairs is a former schoolteacher. I’ve got nothing against schoolteachers, but what does he know of finance? And he’s over there negotiating with the Germans.

“The Germans know what they’re doing. They don’t want to finance our mistakes. And who can blame them?”

In many ways, the Great Correction is hitting Ireland harder than the USA. If the US overbuilt, Ireland overbuilt even more. If the US over-borrowed, Ireland borrowed even more. And if the USA got lost in debt finance, Ireland got lost in dreamland.

“We are dreamers, I guess. And storytellers. It’s a status thing in Ireland. You go into a bar. Look for the fellow who has the most people gathered around him. He’s the big man locally. Not the doctor. Not the politician. Not the rich man.

“We’re dreamers and storytellers…and then, we come to believe our own stories. “

The Irish dream big. The republic is not big enough for them. So they go abroad. Only 4 million of them are left on the island. Some 60 million of their descendants – the Irish diaspora – live in America, Canada, Australia, Argentina and elsewhere. Your editor is one of them.

For the first time in more than a decade, the Irish are emigrating again.

“If you’re a smart young man or woman, what else can you do? It’s sad for their families. But Ireland has nothing to offer them. They have to leave. And usually, they don’t come back.”

Yesterday, we went to open an account at the Bank of Ireland.

“They must have been glad to see you,” said a colleague. “You must be the first person to open an account in years. The rest of us are taking our money out. Every bank in Ireland is insolvent, and everybody knows it.”

“Well, there was no line,” we replied.

Instead, we got to the bank door at 10AM. We rang the doorbell (the bank didn’t open until 10:30, but we had an appointment). A dignified older man in a sweater and a tie opened the heavy oak door.

We stated our business.

“Oh…yes… She’s waiting for you.”

In front of us was an attractive woman of about 30. Well dressed. Well coifed.

“Will I lose my money if the bank goes broke?” I asked.

“Ha ha… There’s no chance of that,” said the woman with a look of earnest intensity that you usually associate with time-share salesmen and insane people. “I guess you would say that we’re already broke, technically. But we have a deal with the European Central Bank. We have a line of credit. We won’t default. And even if we did, your money is protected by an Irish government scheme that protects depositors up to 100,000 euros.”

“Well, isn’t the Irish government insolvent too?”

“Ha ha… Well, I suppose that it is too. Technically. But so is your American government, isn’t it? But this is just a technicality. The whole system is not going to go broke. We’re supported by Europe. And Europe does not want to see Ireland default.”

She was right about that. Europe does not want to see Ireland default. Because the debts of Ireland are the credits of French and German banks. If Ireland were allowed to default, the whole kit and caboodle could come apart.

Ireland can’t borrow on the open market. Lenders are not idiots. So the Micks and Paddies borrow from the European financial authorities. The low rates keep Irish households above water. Most mortgages here are “floating rate” loans. If the rates were allowed to float up to market levels, Irish households, banks, and the government itself, would all sink.

For the moment, Europe lends at low interest rates to the Irish…who keep their banks and voters from going bust. The banks, in turn, keep their creditors from going bust. And so the whole system, in Europe as in America and Japan, depends on a continued flow of artificially cheap money

And everyone seems to think this flow of cheap money can continue indefinitely.

Welcome to the modern political economy… Small, isolated problems are rolled up into bigger and bigger ones. Soon, the danger is not to a bank…or even to a nation…but to the entire system.

We don’t know when it will stop. Nor do we know exactly what will make it stop. But we’re sure there’s money to be made betting on it.

Bill Bonner
for The Daily Reckoning

Read more: Sovereign Debt: a Threat to the Entire Financial System http://dailyreckoning.com/sovereign-debt-a-threat-to-the-entire-financial-system/#ixzz1Fni8BRca

That government projections are not worth the price of the paper (especially not in today’s dis-disinflationary environment) they are printed on is no secret. As Zero Hedge recently demonstrated the margin of error in the most recent budgetary prediction can only be classified as insane. We wrote: “On February 28, 2001 George Bush said this about his 2002 Budget: “It will retire nearly $1 trillion in debt over the next four years.” Instead, US debt, which at that point was $5.7 trillion, rose to $7.7 trillion. $3 trillion rounding error? Also in the same budget, Bush predicted a $5.6 trillion surplus over the next ten years, which would wipe out all of America’s debt by 2011. The latest debt figure was $14.1 trillion. A $14.1 trillion rounding error, or a nearly five fold increase in “rounding errors” in a decade.” So that’s debt, what about budget surplus and/or deficit projections? It’s not any prettier. And courtesy of the NYT we can now see this in an easy to comprehend animation. Following the jump readers can see just how endlessly upward biased projections tend to almost without fail deviate with reality (and unemployment rates as well). The best indication: the 2012 projection to the 2008 budget forecast callsed for a surplus. Now we are expecting a massive deficit. So why do we listen to these monkeys with typewriters again?

Ful animation after the jump:

No surprise: the projected deficit just went up by another half a trillion: “For 2011, the Congressional Budget Office (CBO) projects that if current laws remain unchanged, the federal budget will show a deficit of close to $1.5 trillion, or 9.8 percent of GDP.” This is up from $1.07 trillion: a very small margin of error there. But don’t worry – like true Keynesians the CBO expects that future deficits will have no choice but to go down: “The deficits in CBO’s baseline projections drop markedly over the next few years as a share of output and average 3.1 percent of GDP from 2014 to 2021. Those projections, however, are based on the assumption that tax and spending policies unfold as specified in current law. Consequently, they understate the budget deficits that would occur if many policies currently in place were continued, rather than allowed to expire as scheduled under current law.” So between 2010′s $1.3 trillion, 2011 $1.5 trillion, and 2012′s revised $1.1 trillion, we have $3.9 trillion just in deficit costs to plug. And as Zero Hedge has repeatedly demonstrated the actual debt to be issued is usually about 33% higher than the deficit funding need, meaning that over the next 3 years the US will need to issue about $5 trillion in debt. Which means further debt monetization is guaranteed as foreign investors have now fully withdrawn and the Fed is all alone in gobbling up every dollar in gross issuance. QE3 is guaranteed and we are stunned that the market continues not to realize this.

From the release:

More from Market News:

This despite the expected boost to U.S. GDP this year and in 2012.

And just like their peers at Standard & Poor’s and Moody’s, analysts at Fitch Ratings warned in their latest Credit Outlook that “the absence of a credible medium-term fiscal consolidation strategy is eroding confidence in the sustainability of public finances and commitment to low inflation, with potentially adverse implications for the U.S. sovereign credit standing.”

Still, they note the “higher debt tolerance than for other ‘AAA’ and highly rated sovereigns” due to the “extraordinary fundamental credit strengths” of the U.S., the flexibility and dynamism of its economy and the status of the greenback as a global reserve currency.

Fitch recently had upgraded the U.S. economic growth forecast, expecting the extension of the Bush-era tax cuts to add 0.6% to GDP growth in 2011 and 2012.

It warned, however, that risks stemming from the weakness of the labor and housing markets persist.

The report, titled ‘Navigating a Risk-Laden Recovery’ also warned that fiscal and monetary measures that have been taken also imply risks.

In particular, the second round of asset purchases announced last November by the Federal Reserve — the so-called QE2 — “could undermine confidence in the U.S. dollar and raise inflation expectations.” Inflation expectations would also be fed by the fact that QE2 implies higher asset prices.

It also poses challenges to the rest of the world.

Huh? Challenges? Have these people heard about the Chairman put?

Also what is this BS about inflation and QE2? Don’t they understand that inflation is only there (and it is 100% contained) because it is an indication of the deflation that would have been there had QE not been enacted… or something just as schizophrenic.

Unfortunately for Fitch, their analysts appear to have also not read the World Economic Forum’s massive report which states that unless the world doubles it net leverage in 9 years, we can call it a day. And how on earth can the world double its leverage unless the US continues to monetize between $5-10 billion in debt all day every day. Which is why we urge you to ignore this blasphemy, and keep buying every fucking Russell 2000 dip: after all that is the only indicator His Chairmanness cares about.

Source

01/11/11 Paris, France –

It’s a new decade. Time for a new thought. A new idea. A new theme.

When did we have our last new idea? Was it in this century? We can’t remember.

Fortunately, in the world of money the fewer ideas you have the better. Ideas are usually wrong. They are like mutations. Most are sterile. Dead ends.

Most ideas are dead ends too. Because they are necessarily stupid. At any given time, both in past, present, and future, there are an infinite number of things going on. An idea is merely a way of understanding a little bit of them. You try to capture a part of what is going on…an important part, you hope, in a single metaphor. And you hope others will say: “Oh, that’s what’s going on!”

But in order to put it into a containable, bounded thought…you have to ignore everything else. All the things that don’t quite fit…all the things that make no sense…all the extraneous facts and circumstances. In fact, you have to ignore almost everything that is going on in order to focus on one idea that makes sense to you.

Every idea is like a jealous mistress; she insists that you look only at her. As a result, you miss more than you see…

But that doesn’t stop us from having a good time with an idea from time to time. And we’ve got one today.

We’ll introduce it in a moment…

First, let’s take a look at the news. We begin by noticing that the English seem to have a better idea of what is going on in America than the Americans themselves. The London “Telegraph” reports:

The US is drifting from a financial crisis to a deeper and more insidious social crisis. Self-congratulation by the US authorities that they have this time avoided a repeat of the 1930s is premature.

There is a telling detail in the US retail chain store data for December. Stephen Lewis from Monument Securities points out that luxury outlets saw an 8.1pc rise from a year ago, but discount stores catering to America’s poorer half rose just 1.2pc.

Tiffany’s, Nordstrom, and Saks Fifth Avenue are booming. Sales of Cadillac cars have jumped 35pc, while Porsche’s US sales are up 29pc.

Cartier and Louis Vuitton have helped boost the luxury goods stock index by almost 50pc since October. Yet Best Buy, Target, and Walmart have languished.

Such is the blighted fruit of Federal Reserve policy. The Fed no longer even denies that the purpose of its latest blast of bond purchases, or QE2, is to drive up Wall Street, perhaps because it has so signally failed to achieve its other purpose of driving down borrowing costs.

Yet surely Ben Bernanke’s ‘trickle down’ strategy risks corroding America’s ethic of solidarity long before it does much to help America’s poor.

The retail data can be quirky but it fits in with everything else we know. The numbers of people on food stamps have reached 43.2m, an all time-high of 14pc of the population. Recipients receive debit cards – not stamps – currently worth about $140 a month under President Obama’s stimulus package.

The US Conference of Mayors said visits to soup kitchens are up 24pc this year. There are 643,000 people needing shelter each night.

Jobs data released on Friday was again shocking. The only the reason that headline unemployment fell to 9.4pc was that so many people dropped out of the system altogether.

The actual number of jobs contracted by 260,000 to 153,690,000. The “labour participation rate” for working-age men over 20 dropped to 73.6pc, the lowest since the data series began in 1948. My guess is that this figure exceeds the average for the Great Depression (minus the cruelest year of 1932).

The long-term unemployed (more than six months) have reached 42pc of the total, twice the peak of the early 1990s. Nothing like this has been seen since World War Two.

The Great Correction continues, in other words.

In the markets… The Dow fell 37 points yesterday. The price of gold rose $5. Nothing very important. The news this morning is dominated by Europe’s debt woes. Portugal is the latest nation to suffer an attack by the bond vigilantes. Investors insist on 7% interest to fund Portugal’s budget deficits. That’s less than the 10% they want in exchange for lending to Greece, but it’s 4% more than Germany pays.

Most importantly, it’s too much. Here’s the problem with national debt. When you have too much of it, you’re trapped. You can try austerity. You can try refinancing. You can try to “grow your way out.” But at a certain level of debt, it’s too late. You’re already off the cliff. All you can do is fall.

This is what happened to the Germans after WWI. The reparations demanded by France and Britain were so high that the Germans couldn’t pay. And when they tried to pay, the outflow of capital so weakened their economy that they were even less able to pay.

And imagine a bailout. The Chinese have come to rescue Portugal…and behind the Chinese stands the European bailout fund. But these friendly lenders are a menace. At the end of the operation, you’re in worse shape than you were before.

But maybe the bailouts give you time to “work your way out?” Possibly. But it depends on the circumstances. Greece, for example, owes an amount equal to 130% of GDP. All that debt has to be rolled over…often several times…before it could possibly be paid. Lenders want 10% interest to cover them against the risk of default. If all the debt carried a 10% coupon, it would take 13% of GDP to pay the interest alone. And if Greece could collect taxes at the same rate as in the US, it would take nearly 100% of all tax receipts just to keep up with the interest payments.

Obviously, that wouldn’t work. Greece is working its way INTO more debt, not out of it. The only way out is default, or “restructuring,” to sugar coat the pill.

And now the vigilantes have come ashore on the Iberian Peninsula. They are rampaging through Portugal. How long will it be before they cross the border into Spain? And then, into France?

Bill Bonner
for The Daily Reckoning

Government finances have reached a point where default and/or bankruptcy is unavoidable. After all, we’ve already started to monetize the debt. The inflection point is when total debt reaches a point where the interest on the debt accumulates in an exponential fashion, engulfing the government’s budget. When this occurs at a time when the economy is already weak and running deficits, there essentially is no way out.

Significant runaway inflation and currency depreciation result from a government that essentially can no longer fund itself. It starts when the market sees the problem and moves rates higher. The government then has to monetize its debts to prevent interest rates from rising. Let me explain where we are and why severe inflation is unavoidable and likely coming in the next two to three years.

In FY2010, the government paid $414 Billion in interest expenses which equates to 17% of revenue. When you account for the $14 Trillion in total debt, that works out to be 2.96% in interest. In FY2007, total debt was $8.95 Trillion, but the interest expense was $430 Billion and 17% of revenue. That accounts for an interest rate of 4.80%. Luckily, rates have stayed low for the past two years.

However, in the next 24 months the situation could grow dire. At least $2 Trillion will be added to the national debt. At an interest rate of only 4.0%, the interest expense would be $600 Billion. Even if we assume 7% growth in tax revenue, the interest expense would total 22% of tax revenue . An interest rate of 4.5% would equate to 26% of the budget.

As far as what level of interest expense is the threshold for pain, Russ Winter writes:

Once interest payments take 30% of tax revenues, a country has an out of control debt trap issue. When you think clearly about it, this just makes sense, as the ability to dodge, weave and defer is pretty much removed, as is the logic that it will be repaid in a low-risk manner. The world is going to be a different place when the US is perceived to be in a debt trap.

Is there anyway out of this? Either the economy needs to start growing very fast or interest rates need to stay below 3% until the economy can recover. Clearly, neither is likely. As you can tell from the calculations, interest rates are now the most important variable. If rates stay above 4% or 4.5% for an extended period of time, then there is no turning back.

Judging from the chart below, the secular decline in interest rates is likely over. It is hard to argue with a double bottom, one of the most reliable reversal patterns.

In 2011 and 2012, the Fed will have two new problems on its hands. First, the Federal Reserve will be fighting a new bear market in bonds. They will be fighting the trend. They didn’t have that problem in 2008-2010. Furthermore, the interest on the debt will exceed 20% of revenue, so the Fed will have to monetize more as it is. Ironically, the greater monetization will only put more upward pressure on interest rates, the very thing Captain Ben and company will be fighting against.

As you can see, there is really no way out of this mess, which also includes the states, Europe and Japan. This is why Gold and Silver are acting stronger than at any other point in this bull market. They’ve performed great when rates were low but are likely to perform even better when rates start to rise. This is why we implore you to at least consider Gold and Silver. We’ve created a service that offers professional guidance so that traders and investors can protect themselves and profit from this amazing bull market. Consider a free 14-day trial to our service.

Good Luck!

Jordan Roy-Byrne, CMT
Jordan@TheDailyGold.com

This analysis seeks to update the global sovereign risk of bankruptcy following the developments of the past 9 months that have seen governments and economic policies change, economic austerity plans implemented or failure to implement, as well as the bailout of two Eurozone member countries with first Greece in May and now Ireland’s Euro 85 billion bailout.

My original analysis of March (30 Mar 2010 – Global Sovereign Debt Crisis, Country Bankruptcy Relative Risk of Default ) concluded in the high debt default risks presented by Ireland and Greece, with Belgium, Portugal, UK and Spain not far behind as illustrated by the below graph.

Risk of Bankruptcy / Bailout

The country risk of bankruptcy / bailout represents the current risk of a country going bankrupt and therefore triggering a pre-default bailout (if affordable). This takes into account each countries current GDP growth rate, total public debt, public and banking sector liabilities, budget deficit, total external debt and sovereign bond market interest rates, other determinants include the ability to devalue and part inflate ones way out of debt which is not possible for most eurozone members.

The bailout mechanisms that the euro-zone has implemented to date only act to delay ultimate bankruptcy where in Greece and Irelands case involves financing the next 3 years or so of deficits and debt rescheduling which has the effect of adding to a bailed out countries total debt burden and therefore increases the debt pressures on the economy as debt interest as a percentage of GDP rises each year until the country is forced to restructure its debts.

The Contagion Factor

The risk of debt default contagion measures the global impact of each country going bankrupt as a percentage of between 0% and 100%, where the US equals a 100% risk in terms of what the fallout would be on the global financial system if the United States went bankrupt, which at 100% implies that the whole worlds financial system and probably economy would collapse.

For instance Iceland going bust during October 2008 had little contagion effect because of its relatively small economic size and external debt foot print, whereas countries such as Ireland have a far greater contagion effect, hence the E.U. / IMF bailout of Ireland which at Euro 85 billion is far less than the impact of contagion spreading and increasing the risks of default in other larger countries as counter parties to Irish banks and holders of Irish debts would come under pressure.

However, a bailout does not wholly negate the contagion risk factor as bond holders and counter parties would still be subject to the likelihood of a debt restructuring at some point in the future which therefore would still to some extent elevate the risks of default for all other exposed countries. The key data used to determine the contagion effect is the size of the economy and total debt and liabilities including external.

Debt Default is Inevitable for All Countries

All countries are trending towards debt default / restructuring. However most countries are defaulting on their debt by means of high real inflation, therefore outright debt default risk is lower for most countries as they are able to avoid a debt default / IMF bailout by eroding the value of public debt by stealing the wealth of savers and purchasing power of workers earnings through inflation.

For instance the UK government prints money that it loans to the bankrupt banks at 0.5% to buy UK government bonds at 3.3%, hence why the yields are lower than the likes of Spain and Italy, which acts as a safety valve preventing outright default, but the price paid is in high inflation, with the doctored official inflation measure of CPI is at 3.2%, the more recognised RPI at 4.5% and real inflation at 6% as the following graph illustrates.

The CPI inflation trend is inline with forecast expectations as of December 2009 (27th December 2009 (UK CPI Inflation Forecast 2010, Imminent and Sustained Spike Above 3%).

The inflation stealth debt default is reflected in this analysis as a lower risk of outright debt default / bailout, as the higher the real inflation rate is (upto a limit) then the lower will be the relative risk of outright default as governments use inflation to steal the value of earnings and savings to reduce the value of debt.

Also considering that all currencies are in perpetual free fall against one another to achieve the same default through inflation outcome then usually the debt denominated in foreign currencies should pose less of a problem than that denominated in the domestic currency than many commentators perceive it to be. For instance Britain’s stealth inflation debt default is reflected by the British Pound in exchange rate terms being roughly where it was against the U.S. Dollar 20 years ago, however the following graph shows that sterling has lost over 40% of its purchasing power on the RPI inflation measure over the past 20 years.

Also having more of ones debt in the domestic currency does reduce the risk of default, which is why the United States risk of default remains very low.

At the other end of the currency devaluing high real inflation debt spectrum are the Euro-zone PIGIBS that are locked in the Euro and thus cannot default by high real inflation and even if they left the Euro would not address the fact that their debt is denominated in Euro’s unless all of their debt at the same time was also converted into the new currency resulting in an instant huge devaluation (probably an hyper inflation panic event). Therefore whilst the PIGIBS remain in the Euro-zone then they can only devalue internally by cutting wages and spending so as to make their economies more competitive against other Eurozone members. Though the flaw here as opposed to using inflation to default on debt denominated in local currencies is that as the economy contracts the debt increases as a % of GDP and hence over time the risk of default increases which is why the Euro-zone members will probability require continuous bailouts until they default on their debts which is inevitable.

Sovereign Debt Default / Bailout and Contagion Risk Graph – November 2010

The updated analysis is presented as a graph with the two axis as the Sovereign Risk of Bankruptcy / Bailout and the Contagion Factor.

Ireland - Has now been bailed out at a cost of Euro 85 billion. In terms of debt contagion Ireland at 15% posed a far greater risk than Greece, which means that if Ireland had outright defaulted on its public and banking sector debts then it probably would have crashed the global economy, hence the bailout.

Portugal - Is at a current default risk of 43%, the graph confirms the current consensus view that Portugal is next inline for a bailout. However the risks that Portugal poses to the global financial system in terms of contagion factor at 4% is far less than that of Ireland. Estimate Bailout cost Euro 80 billion

Belgium – At 29%, continues to pose a high default risk and stands next after Portugal for a bailout, especially as the contagion risk at 10% is more than double Portugal’s . Estimated bailout cost rises to Euro 175 billion.

Spain – At 26% risk of default carries a 16% Contagion factor. Spain is a much larger economy, hence the estimated bailout costs now start to jump substantially by rising to Euro 550 billion.

Italy – At a current default risk of 17%, suggests that Italy could survive for several more years, however if Portugal, Belgium and Spain are bailed out then Italy would come under far more pressure. The contagion factor for Italy is similar to that of Spain of 16%. A bailout would cost an estimated Euro 800 billion.

UK – Has an improved risk of default of 14% since the March update as a consequence of coalition government measures and due the UK’s ability to stealth default by means of high real inflation. However should all of the above have defaulted / been bailed out then the pressure on UK would become very high which would manifest itself in a severe plunge in sterling. The UK has a contagion factor of 61%, second only to that of the United states which means that should the UK default then it definitely would being down the worlds financial system and global economy with it. A bailout to prevent bankruptcy would cost an estimated Euro 850 billion.

France – At 12% risk of default, has a high contagion factor of 34%, which means that if France should ever default then it would probably take the global financial system down with it. A bailout would cost an estimated Euro 1 trillion.

Bailouts - Again bailouts just delay the inevitable debt restructuring.

Contagion factor - The most important factor is the contagion factor, where countries approaching default, even if they are subsequently bailed out could still crash the global financial system if their contagion factor is high such as that for the UK, France and Germany. Luckily there is no sign that any of these three is likely to reach a critical state that risks debt default / bailout during the next 6 to 12 months, so have time on their sides to address budget deficit and bank debt issues.

Also despite widespread speculation surrounding US debt and liabilities, the United States remains at a low overall risk of default at 5%, though up on March’s 3%.

Another an important factor to note is that countries such as Pakistan, Mexico and India are at a far lower risk of default because their external liabilities are smaller and debt metrics less critical compared to that of Euro-zone members, which is why the likes of Greece, Ireland and Portugal have required bail outs whilst the former have not, as the original analysis of March 2010 implied that the debt risk world has been turned upside down where those that were deemed to be high risk countries a couple of years ago are now low risk and those that were low risk are now high risk countries.

Conclusion

Whilst Portugal is next with Belgium and Spain to also trigger a probable bailout of sorts during the next 12 months. However it is possible that a line could be drawn under the bankrupting PIGIBS with Spain, especially if new mechanisms are introduced by the Eurozone for a more orderly partial debt restructuring that is able to release pressures on the likes of Italy and France and therefore have far less of a contagion effect.

In the meantime all savers and depositors should seek to protect their wealth and savings against the risk of PIGIBS contagion by ensuring that they limit their exposure to PIGIBS banks and that their savings are within the compensation limits as discussed at length in the recent article (26 Nov 2010 – Euro Debt Crisis Bankruptcy Bailout Queue, Protect Savings & Deposits From Banks Going Bankrupt! ).

Debt Crisis Solutions – Mechanism’s for an Orderly Partial Debt Default / Restructuring

As mentioned in the recent analysis (14 Nov 2010 – Bankrupting Ireland in Economic Depression Announces Policy of Quantitative Cheesing), the Eurozone needs to develop orderly mechanisms for partial debt restructuring to take place so as to prevent outright default, triggering a costly full bailout. The current system of the ECB funding the bankrupt European banks at 1% is not working, as it is the primary reason for the current sovereign debt crisis as after the 2008 credit crisis the European banks took ECB cash and bought high yielding PIGIBS debt with it, hence the current crisis.

One mechanism to address this is if future PIGIBS bond issuance was sold on the basis that a certain percentage of the debt could be defaulted on if the issuing government at the time of maturity had a high budget deficit. This would result in higher interest rates for PIGIBS debt to reflect the risks of partial default as well as produce an orderly market for slow serial debt default rather than crisis events that hits the sovereigns whole bond market i.e. it could be on the basis that an issue of 10 year Portuguese debt at a 8% interest rate would lose 3% of its capital on maturity for every 1% that Portugal’s budget deficit was above the 3% deficit target, or utilise some other similar measure.

However the above mechanism would only apply to future debt and it would take many years for new default prone debt to replace existing debt, therefore there needs a mechanism to restructure existing PIGIBS debt, especially for Greece, Ireland and Portugal as their debt remains unsustainable. The difficulty here is in partially defaulting on Greece Ireland and Portuguese debt without triggering a Euro-zone wide bond market panic, where the only country that could attract bond market investors would be Germany.

Clearly the mechanism for restructuring PIGIBS debt would be for the ECB to restructure the Eurozone banks so as to separate public debt from bank debt. Much as Ireland is being forced to do with regards its banks, which should instead fall under the responsibility of the ECB which would reduce the burden on PIGIBS from banking sector liabilities.

During the past week there have been some signs that the Eurozone does intend on enacting some sort of ultimate haircut for bond market investors so as to reflect the risks. However there is no sign that any member country wants to leave the Euro-zone, which for especially Greece and Portugal would probably be in their long-term best interests as their economies will never be able to compete against the likes of Germany on a level playing field and therefore look set for a decade of low growth compared with the industrialised Euro-zone. Similarly neither will Germany leave the Euro-zone as it relies on the Bankrupt PIGIBS to keep the Euro weak whilst also exporting to a captured internal market.

At the end of the day, bond markets need a reason to buy sovereign debt, if there is a great deal of uncertainty as to what they will get back on maturity then they won’t buy it. Therefore the Eurozone needs to introduce certainty for the bond markets for especially the PIGIBS debt market to function, otherwise the only buyer of the their debt will be the ECB.

U.S. Dollar Trend Quick Update

The Dollar has apparently benefited hugely as a consequence of the Eurozone debt crisis of the past few weeks by rising from a low of 76 in early November to a high of nearly 81 last Friday, which is being taken by many to infer that the dollar has entered new bullish phase that possibly targets a bull run to as high as USD 90.

However the trend whilst coming as a surprise to the dollar collapse merchants and triggering the emergence of a new bullish consensus, is inline with the last in depth analysis and trend forecast into Mid 2011 (12 Oct 2010 – USD Index Trend Forecast Into Mid 2011, U.S. Dollar Collapse (Again)?) that forecast a bullish trend for the USD from 76 to target USD 80 by early December. The forecast path for the dollar should now be for the primary downtrend to resume towards a Mid 2011 target of between 69-70.

Similarly Sterling should resume its uptrend against the US Dollar which targets a trend to £/$1.85 by mid 2011 (04 Oct 2010 – British Pound Sterling GBP Currency Trend Forecast into Mid 2011). Therefore the current price of £/$ 1.5580 should should represent the approx low point for the whole move from 163.

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Comments and Source: http://www.marketoracle.co.uk/Article24619.html

By Nadeem Walayat

http://www.marketoracle.co.uk

Copyright © 2005-10 Marketoracle.co.uk (Market Oracle Ltd). All rights reserved.

Nadeem Walayat has over 20 years experience of trading derivatives, portfolio management and analysing the financial markets, including one of few who both anticipated and Beat the 1987 Crash. Nadeem’s forward looking analysis specialises on UK inflation, economy, interest rates and the housing market and he is the author of the NEW Inflation Mega-Trend ebook that can be downloaded for Free. Nadeem is the Editor of The Market Oracle, a FREE Daily Financial Markets Analysis & Forecasting online publication. We present in-depth analysis from over 600 experienced analysts on a range of views of the probable direction of the financial markets. Thus enabling our readers to arrive at an informed opinion on future market direction. http://www.marketoracle.co.uk

Ireland’s Government drops the mantra of no bailout by finally coming clean to the Irish public that a multi-billion Euro bailout has been agreed ahead of markets opening on Monday. Many Irish citizens will be angry that they have been repeatedly lied to as a series of senior government politician’s have stepped forward these past few weeks to make announcements that Ireland was not seeking a bailout when the facts where the complete opposite as an accelerating bank run was under way on Irish banks, with depositors having already pulled out an estimated Euro 25 billion.

Emerging Bailout Details

The key bailout test was whether or not Ireland would retain its 12.5% Corporation Tax, which has attracted a number of giant multi-nationals to relocate to Ireland such as Google, Pfizer and Microsoft, much to the annoyance of other European countries, and especially France and Germany who had this at the top of their conditions hit list. The fact that Ireland has apparently retained sovereignty over corporation tax bodes well for eventual economic recovery as the relocated multi-nationals account for more than 70% of Irelands exports and generate more than 50% in corporation tax revenues, without which Ireland truly would be bust for the next decade.

However whilst Ireland can claim victory on capital gains tax, it did pay a heavy price elsewhere as it effectively handed over economic sovereignty to the ECB for at least the next 3 years.

• E.U. financing of Irish government deficit for the next 3 years (Euro 40 billion).
• International Bond Markets effectively closed to Ireland for the next 3 years.
• Ireland’s bankrupt banks to be fully nationalised (re-capitalisation) then broken up (Euro 50 billion).
• Ireland to enact further tax rises and spending cuts aimed at reducing the budget deficit to 3% of GDP by 2014.

Ultimately much of the bailouts debt will have to be inflated away by higher Eurozone inflation(stealth debt default), especially as other PIIGS are also lining up for a bailout, coupled with restructuring of Irish banks debts (outright debt default).

Bailout was Inevitable

The Irish are trying hard to put up a brave face on the loss of sovereignty (as will soon will Portugal and Spain ) that they really don’t need a bailout, however as I pointed out earlier in the week(18 Nov 2010 – Ireland Bailout Imminent, Press Euro-zone Breakup Speculation, Germany Leaving the Euro?) the Governor of Irelands Central bank, Patrick Honohan gave the game away with his statement:

“There will be a large loan because the purpose of the amount to be advanced, or to be made available, is to show Ireland has sufficient firepower to deal with any concerns of the market, so we’re ’re talking about a substantial loan, tens of billions, yes.”

The Euro, stocks, bonds and commodity markets leapt higher on the comments, by all bouncing higher off their recent lows in anticipation of a Euros 80-100 billion bailout inline with my going analysis that given’s Irelands bankrupt banks bankrupting Ireland, a bailout of Ireland is inevitable (14 Nov 2010 – Bankrupting Ireland in Economic Depression Announces Policy of Quantitative Cheesing)

Bottom Line: Where Ireland is concerned, the E.U. will do its best to delay the inevitable debt default, which means a Eurozone bailout (one of a series) is imminent, because if one of the PIIGS defaults then so will they all which would require the mentioned Euro 2 trillion QE bailout virtually immediately (a Euro 750 billion bailout fund was announced in May), rather than perhaps Euros 80 billion for Ireland on its own at this stage of the crisis, and after Ireland will soon follow Portugal, then Spain, then Italy before the bailout cycle returns once more for another Greece bailout (probably sooner rather than later). All of which feed the Inflation mega-trend across the Euro-zone.

The press has been full of commentary of a bailout for Ireland as news, when it has been an INEVITABLE eventuality given the fundamentals (13 Apr 2010 – Britain’s Accelerating Trend Towards High Inflation and UK Debt Default Bankruptcy ) (Graph now needs updating following developments of the past 8 months).

Whilst the mainstream press these past two months has been obsessed with the Greek debt crisis, the above graph clearly illustrates that a far larger debt crisis looms in Ireland that could soon transplant Greece in the debt crisis headlines over the coming months, similarly a number of other Euro Zone countries head the risk towards bankruptcy league table with Belgium and Portugal not far behind Greece. The price that these countries pay for being stuck in the Euro single currency is that they cannot devalue to try and gain some competitive advantage for their economies and therefore try and grow and inflate their way out of a high debt burden that stifles economic activity.

The bailout has been on the card not just for the last few weeks or even the whole of 2010, but a bailout of Ireland has been on the cards since it first bailed out its three big bankrupt banks back in late 2008. Ireland had only managed to DELAY the INEVITABLE purely as a consequence of being IN the Eurozone which allowed Ireland to borrow at very low interest rates and without suffering an inflationary currency collapse that hit Iceland hard when its banks blew up in September 2008 and the money markets completely froze to financing of both Icelandic banks and the state which required an immediate E.U./ IMF bailout just to keep Iceland’s economy ticking over on life support.

So whilst an angry Irish population may blame the Euro-zone / ECB, need to realise the facts that the Eurozone has saved Ireland from a far worse economic catastrophe Iceland style and therefore if they need someone to blame they first need to look at their banks which have been haemorrhaging deposits to the tune of Euro 25 billions over the past few weeks, and then at their lying politicians and finally in the mirror at themselves for ratcheting up personal debts on the basis of cheap Euro-zone cash, where the Irish state and banks were able to borrow as though it were Germany but without any of the regulatory framework, discipline or deep financial pockets that Germany has.

The markets have immediately reacted strongly to the news by bouncing higher in asia, as some uncertainty has now been removed from the market place, though there is plenty of room for more market / eurozone wobbles especially as Portugal which is in an even worse state than Ireland teeters on the brink of a bailout, with Spain not far behind.

I highlighted possible solutions in an earlier article (14 Nov 2010 – Bankrupting Ireland in Economic Depression Announces Policy of Quantitative Cheesing), which boil down to stealth default by inflation and bank debts restructuring (overt default). Therefore the bailout (loan) just continues to delay the inevitable as it makes Irelands debt situation far worse, as another Euro’s 100 billion of debt has been piled onto Irelands already huge debt mountain that Ireland can NEVER REPAY in real terms.

The Euro-zone needs to develop mechanisms that allows member countries to go bankrupt in a more orderly manner without impacting on the rest of the Eurozone, this would make the Euro currency FAR stronger, and make future debt crisis events more localised to small economies such as Greece, Ireland and Portugal. Off course first the European regulators need to extract their bankrupting banks from the bankrupting PIIGS. It is a very messy situation, where financially immature nations were wrapped in the persona of the Euro, enabling their banks to virtually borrow unlimited amounts of money at ultra low interest rates.

Ireland / PIIGS Debt Crisis Consequences for Britain

Whilst the mainstream press’s immediate focus is on the estimated Euro 7 billions that Britain will contribute towards Irelands 80-90 billion bailout. However the real costs to Britain of Irelands and the other PIIGS debt crisis is far larger and most directly visible in an estimated 1/2 million rise in UK unemployment over the next 2-3 years, as I voiced in Julys UK Unemployment forecast (01 Jul 2010 – UK Unemployment Forecast 2010 to 2015):

UK unemployment looks set to remain on an upward trajectory for the next 3 years, after which it should feel the effects of the election boom. However against these positives there will be the impact of European Migrant workers that could take up as much as 70% of the new jobs created, which suggests that even if the government is able to create its forecast 2.5 million jobs (which I doubt), then at least 60% of these jobs will go to migrant workers, leaving less than 1 million new UK jobs for British citizens. This does not paint a very rosy picture for the governments expectations for UK unemployment to fall to below 2 million.

At least a 1/2 million flood of highly able and motivated workers from the bankrupting PIIGS to seek and find work in Britain ensures that the Governments expectations for UK unemployment to fall below 2 million is not going to be realised. Instead UK unemployment now has a greater probability of reaching as high as 3 million over the next 2-3 years as illustrated by the original forecast graph.

The inability to combat rising unemployment will put Britain’s finances under further strain despite all of the announced austerity measures as on average it takes approximately 4 tax payers to support each unemployed worker, so tax revenues from 500,000 migrant workers will not to any extent be able to cover the costs of unemployment rising by 1/2 million, so despite a growing economy, the workers of Britain will feel even less secure over the coming years than they did at any point during the Great Recession. The ultimate cost to Britain of 1 million extra unemployed (against government expectations) in large part as a consequence of migrant workers is estimated at £40 billion / Euros 48 billion over the next 3 years.

The Key Lessons From Ireland’s Banking Crisis Are NOT Being Learned

The key lesson from Ireland is BIG BANKS Should be BROKEN UP!, Irelands THREE big banks have bankrupted the nation which collectively have liabilities at over 200% of Irelands GDP. NO lessons have been learned in Britain either, as on the one hand there is the giant bailed out Lloyds / HBOS monster and on the other hand the UK regulator has let Spain’s Santandar run amok by gobbling up half a dozen small to medium sized banks. Which means more liabilities dumped onto UK tax payers when Spanish banks send Spain over the edge of the cliff!

David Cameron’s government is increasingly one of smoke and mirrors as I wrote earlier in the month (11 Nov 2010 – Is David Cameron a Socialist? Time for a Tea Party for Britain ? ). There is no sign that the Conservatives will do ANYTHING to prevent another financial crisis by breaking up the power of the big banks by ensuring that retail banks cannot become too large or be allowed to play in the global derivatives casino.

Portugal Next ?

Ireland’s Euro 90 billion bailout follows Greece’s 110 billion. The bond markets are suggesting that next is Portugal that is seeing its 10 year bond yields rise to 6.75%. The debt problem with Portugal is not as a consequence of a bankrupt banking sector but that the Portuguese economy is highly uncompetitive, and badly managed that in reality should never have been accepted as part of the Euro-zone along the same lines as Greece, as unlike Ireland there is no solution to Portugal’s debt and deficits. However the good news is that a bailout of Portugal ‘should’ be far less costly, perhaps Euro 40 billion over the next 3 years.

However after Portugal comes the really big problem economies of first Spain and then Italy.

UK CPI Inflation Rises to 3.2% as the Inflation Mega-trend Continues

The inflation mega-trend continues to manifest itself as UK CPI nudged higher to 3.2% for October from 3.1%, whilst the Bank of England continued with its deflation threat propaganda so as to prevent a wage price spiral from taking hold. Whilst the highly doctored CPI came in at 3.2%, the more recognised RPI came in at 4.5% with real UK inflation still at a high 6% as illustrated by the below graph.

The CPI inflation trend is inline with forecast expectations as of December 2009 (27th December 2009 (UK CPI Inflation Forecast 2010, Imminent and Sustained Spike Above 3%)

The Deflation Delusion Money Printing Cycle

Deflationists continue to play the pick and choose game so as to pretend they understand what is going on whilst the Inflation mega-trend passes them by (18 Nov 2009 – Deflationists Are WRONG, Prepare for the INFLATION Mega-Trend ) . One of the tricks utilised is to focus on core inflation that excludes food and energy costs, as if to imply that people have stopped eating and warming themselves therefore energy and food prices do not matter anymore, off course the reason they are being ignored is because they have risen sharply, and hence people do not have any money left over to BUY core inflation items and hence WHY core inflation is LOW and so the cycle repeats where the central banks focus on core inflation to imply deflation, use it as an excuse to PRINT MONEY which forces UP food and energy prices that acts as a TAX on consumption of core inflation items and off the central bankers run again on their self induced perpetual money printing deflation risk cycle! All central banks are engaged in the same money printing because of deflation threat game that benefits the big banks.

I can imagine a day will come when the government starts to advocate that inflation indexation should be inline with Core CPI to further enhance the stealth real inflation fraud. For more on the Inflation Mega-trend and Deflation Delusion download the FREE Inflation Mega-Trend Ebook.

The following excellent video explains how Fed deflation propaganda is used to convince the masses that printing money is good, which is then funneled to Goldman Sachs and other Wall Street Bankster’s.

Apparently according to the Ben Bernank, the secret to growing economies is by printing money and having fake inflation and unemployment statistics, as long as the banks profit he is all smiles.

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Stock Market Quick Update

Last weeks analysis concluded in a continuing down trend as of the 11,380 trigger to target a low of 10,950 for a relatively mild correction (15 Nov 2010 – Bank of England Inflation Propaganda Suggests Invisible Depression, Bankrupting Ireland Seeks Bailout ). The Dow put in a low of 10,979 before rallying and closing on the week at 11,203.

The big picture trend in line with the last in depth analysis (18 Oct 2010 – Stocks Stealth Bull Market Dow Trend Forecast into Jan 2011) is for a correction into Mid November to resolve into a rally that targets Dow 12k by Mid Jan 2011. Therefore the stock market has now entered the time window for the rally to 12k. The last Dow close of 11,203, puts the index about 300 points above its forecast trend by this point in time which suggests to me a volatile sideways to downtrend price action over the coming week that risks breaking the 10,976 low after Monday’s bullish reaction to Ireland’s Bailout.

How long has the Stocks Bull Market left to run ?

It is hard enough to see a couple of months forward, hence the in-depth analysis every couple of months or so. I still see the stocks indices such as the Dow targeting new all time highs, time wise, I am getting the impression that we could have passed the mid-way point, which suggests a 1 to 1-1/2 years to go before we have a bear market (of sorts), by which time time the perma bears will have thrown in the towel and turned into bulls or attempt to rewrite history and state that they called the 2012 stock market peak whilst having called virtually every correction as the end of the bull market for the preceding 2-3 years! Just as they did during previous bull market that peaked in 2007!

How Bad Could the Bear market be?

Now I really am gazing into the a fuzzy distant future by contemplating this question. The stock market is in an inflationary growth spiral, therefore the next bear market will be CORRECTING the current bull market and thus will NOT be the likes of 2008-2009. It is way too early but I can guesstimate a 50% retracement of the whole bull market over 1/3rd of the time. But lets enjoy riding and profiting from the STEALTH bull market first before we start worrying about the next ‘corrective’ bear market.

Gold, Silver, Oil Quick Comment - Since many markets are highly correlated to stocks at this moment in time, gold, silver, and oil could also experience a volatile downtrend during the week after Monday’s bailout bounce.

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Comments and Source: http://www.marketoracle.co.uk/Article24459.html

By Nadeem Walayat

http://www.marketoracle.co.uk

Copyright © 2005-10 Marketoracle.co.uk (Market Oracle Ltd). All rights reserved.

Nadeem Walayat has over 20 years experience of trading derivatives, portfolio management and analysing the financial markets, including one of few who both anticipated and Beat the 1987 Crash. Nadeem’s forward looking analysis specialises on UK inflation, economy, interest rates and the housing market and he is the author of the NEW Inflation Mega-Trend ebook that can be downloaded for Free. Nadeem is the Editor of The Market Oracle, a FREE Daily Financial Markets Analysis & Forecasting online publication. We present in-depth analysis from over 600 experienced analysts on a range of views of the probable direction of the financial markets. Thus enabling our readers to arrive at an informed opinion on future market direction. http://www.marketoracle.co.uk