It’s the Debt, Stupid

From last week, this article from Seeking Alpha, provided by The Pragmatic Capitalist (TPC), reminds us that sovereign debt is a big problem, but not the only one. 

The sovereign debt problem is today making big waves in Europe, as noted at Zero Hedge.  And, yes, it has implications for underlying currency strength as is also being demonstrated today….

Still, it is quite amazing to see the money rats scurrying from one sinking ship to another.  The DXY, it may be noted is comprised of roughly 83% Euro, Yen & Pound, all of which are in as dire shape as the dollar.  Arguably, the Euro might have more legs than  the others, not being as easily debased as a single-nation currency.  (Of course, we don’t know where the current problem with Greece, et al, will lead….amputation? bailout?)

Thus, while we focus on the RELATIVE strength of a basket of very weak currencies via the DXY, we lose sight of just how low all of these ships are sitting in the water.  One might imagine that soon we’ll all be arguing about “safe-haven”  moves and carry-trade plays using sign language in our SCUBA gear. 

Which, as it happens, is just another way of saying that quite soon the market will be looking for a reliable (if ironic) “flotation device”.  You know the one I’m talking about….don’t you?   

And, on that topic, it may be time to understand the degree to which “paper” is causing problems in “gold-land” as well.  Jim Willie, of (yes, I know), citing Robert Prechter, among others, yesterday writes:

There is going on a lot more than meets the eye. The physical system is actually consolidating bigtime and is organizing itself with lightning speed, totally hidden from pretty much anyone, even the so-called insiders. The paper precious metal market and the physical precious metal market have defacto disconnected. The paper and physical gold markets currently operate in parallel universes. The outflow of physical metal from bank vaults is happening at a mind bending pace.”. 

In a word, all these various debt paths lead to one destination in the end, and it’s a place where the real value of paper is exposed for what it really is…..”the full faith and credit of the printing presses of _______ (fill in the blank).”

The other problems noted above?  Well, sovereign’s are but a small slice of the total debt pie, as noted in an earlier post.  What we really ought to be paying attention to is total debt and, of course, total debt to GDP.  That is to say, what is our total collective liability relative to our ability to pay it off? 

Aside from the ludicrous Keynesian notion that government debt needs to “pick up the slack” in the private sector, we ought to realize that there is a relationship between debt incurred – notably it’s type – and whether or not it’s likely to produce any real growth. 

As the TPC article noted above explains, it took $1.53 in debt to produce $1 of GDP growth in the 1960s.  By this last decade, it took more than $6 to produce that $1 of growth.  And this is how a nation goes from 150% total debt to GDP to nearly 400% in four decades.  Might this tell us something about the destructive power of accumulating the “wrong kind” of debt?  

So, if you insist on comparing sinking ships to one another, consider the US total debt-to-GDP ratio of 375% to the following: 

UK —- 470%

Japan —- 460%

Spain — 340%

South Korea —- 340%

Switzerland —- 315%

France and Italy —- about 300%

Germany —- 275%

Canada —- 245%

It may be noted that all of the above are records levels of debt to GDP.  The BRIC countries (Brazil, Russia, India, and China) all have debt to GDP under 160%, roughly where the US was in the 1960’s.  As it happens, both the lighter overall debt burden and the relative absence of inertia-draining government and consumer debt help to explain quite a bit of the rapid growth in those economies. 

And, by the way, it’s these relatively healthy BRICs that really need gold as a backstop against the rest of the world’s insanity.  Forget about you and me for the moment, these emerging economies are dependent on their exports, mostly paid for with depreciating dollars or other sinking currencies. 

What to do?  Allow prices to rise through a free-floating currency exchange?  Not yet, for China at least.   Whether or not this policy is the “lesser evil” open to them at the moment, it seems clear that an exchange of any negative interest bearing debt instrument (like, say, the dollar) for hard assets makes a lot ot sense.  As the single largest recipient of such instruments, we Americans might look to that as “good advice”, eh?  

Note also that the current decline in gold and silver prices (in dollars) reflects, first and foremost, discounting resulting from the present and temporary relative strength of the dollar compared to the Euro.  You do realize that gold priced in Euros is rising to a similar degree, don’t you?   

Whether or not India’s central bank purchase of 200 tons of IMF gold back in November at $1,045 per ounce will prove to be a resilient level of support – again, in dollars – may well be tested today.  Regardless, we ought not worry too much about these short-term DXY influences, as it tells us almost nothing about our own risk of drowning.

Harry Tuttle


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