May 10, 2012: Charts that Count - Sovereign Debt and Monetary Malfeasance Insurance


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According to the Canadian Taxpayers Federation "Canada's federal debt grew steadily between 5% and 10% per year until 1975 when it began to explode; growing for the next 12 years at more than 20% per year. It broke the $100 billion mark in 1981 and the $200 billion mark in 1985. While the growth slowed in 1988, our federal debt continued to climb, breaking $300 billion in 1988, $400 billion 1992, and $500 billion in 1994. It peaked in 1997 at $563 billion. Between 1997 and 2008, it slowly declined to $458 billion. After that, it all changed."

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May 10, 2012: Charts that Count - Sovereign Debt and Monetary Malfeasance Insurance

  1. 1. May 10, 2012Charts That CountSovereign Debt, Central Bank Balance Sheets and Monetary MalfeasanceInsuranceAccording to the Canadian Taxpayers Federation "Canadas federal debt grewsteadily between 5% and 10% per year until 1975 when it began to explode;growing for the next 12 years at more than 20% per year. It broke the $100 billionmark in 1981 and the $200 billion mark in 1985. While the growth slowed in 1988,our federal debt continued to climb, breaking $300 billion in 1988, $400 billion 1992,and $500 billion in 1994. It peaked in 1997 at $563 billion. Between 1997 and 2008,it slowly declined to $458 billion. After that, it all changed. Our federal debt grew by$5.8 billion in 2008-09, by $55.4 billion in 2009-10, $34 billion in 2010-11, $31 billionin 2011-12. Its expected to grow by $21.1 billion in 2012-13. Further, its expected togrow until 2015-16. In just three years from 2008 to 2011 all the debt repayment($105 billion) of the previous eight years was completely wiped out."Each Canadians share of this debt amounts to approximately $16,000. Surely therewill come a point where the national debt will stop being an ideological debatingpoint and simply become a mathematical issue - the ability or more accurately theinability to repay in real terms.And on the small matter of repayment - lets examine these debt levels in moredetail. When you calculate complete public debt loads for various countries andinclude that often and conveniently overlooked matter of the future obligations forunderfunded social programs, the picture does not appear promising (Note: Thecountry labeled GRE to the left of the US and therefore with LESS public debt isGreece).Chart 1: Public Finances (% of GDP)Source: Morgan Stanley
  2. 2. But before we become too smug in Canada with our relatively "low" governmentdebt levels lets not forget that simply looking at public finances does not tell thewhole story. When you take into account total debt levels - Canada is at around250% of GDP and notwithstanding the hypocritical concern of the Bank of Canada,continues to grow with the support of the historically low interest rates said bank hasengineered. I believe Canada is going to face some debt challenges of its own inthe not-too-distant future. Chart 2: G10 Debt DistributionSource: Haver Analytics, Morgan Stanley ResearchRemember that this chart does not attempt to account for the net present value offuture healthcare and pension costs which due, to the proverbial "pig in the python"effect of the retiring baby-boomer generation, are due to escalate significantly.What happens when a state can no longer service its debt? Just like any otherstruggling borrower it defaults. How often does this happen? More often than youthink and with a disproportionate number taking place in recent history.
  3. 3. Chart 3: Sovereign Defaults (Total number by period)Source: EconopicdataDe jure sovereign defaults also exhibit an alarming tendency to occur in clusters -not a promising characteristic if this were to prove to be the case in our ongoingepisode of sovereign debt distress.Chart 4: Sovereign Defaults or Restructurings (Number per year: 1824 - 2010)Source: UBS AGSadly the two charts above actually understate the problem as they only cataloguede jure defaults and of course sovereign borrowers have a path not open to theaverage debtor on the street - they can print money. There have been many moresubtle and pernicious de facto defaults arising from expansionary money supply
  4. 4. policies. In fact, one could argue that currency devaluation is the preferred defaultmethodology of modern governments - witness the 97% loss of purchasing power ofthe US dollar since the inception of the Federal Reserve and the 95% loss ofpurchasing power of the Canadian dollar since the inception of the Bank of Canada.Despite the gravity of our current problems you might still conclude that sovereigndefaults have occurred many times in the past and we survived them so how is ourcurrent situation any different? One word - "scale". To put the size of possiblecurrent sovereign defaults into perspective with those of the past - the largestnominal sovereign default in the world to date was Argentina in 2001 totaling $82billion. The Eurozone PIIGS debt totals $4,800 billion.Knowing this, an inflationary default, if pursued, would have to be commensuratelylarge. Food for thought.Certainly, the monetary powers that be show no sign of shying away from the task ofproducing the raw material for an inflationary default. I doubt it will come as asurprise to anyone who has been following the parabolic trajectory of global moneysupply that according to Lawrence Goodman, president of the Center for FinancialStability, the Federal Reserve has effectively become the dominant/marginal buyerand therefore the market for US government debt: "Last year the Fed purchased astunning 61 percent of the total net Treasury issuance, up from negligible amountsprior to the 2008 financial crisis ...This not only creates the false appearance oflimitless demand for U.S. debt but also blunts any sense of urgency to reducesupersized budget deficits."US Federal Reserve intervention in the government debt market is replacingdemand from foreign lenders. Goodman notes that where once Japan and Chinahad virtually an unlimited appetite for U.S. debt (tied to their need to recycle their USdollar surpluses as part of a mercantilist policy of suppressing the exchange valuesof their currencies) this may be waning.Goodman goes on to say "The Fed is in effect subsidizing U.S. governmentspending and borrowing via expansion of its balance sheet and massive purchasesof Treasury bonds. This keeps Treasury interest rates abnormally low, camouflagingthe true size of the budget deficit...Similarly, the Fed is providing preferential creditto the U.S. government and covering a rapidly widening gap between Treasurysneed to borrow and a more limited willingness among market participants to supplyTreasury with credit."The possibility that an inflationary default (at the very least in part) will be pursuedby the G10 nations should be given some non-zero weighting in your investmentdecision-making. Even if you assign a low probability to such an event, the
  5. 5. consequences are obviously material. If you prefer, think of this exercise as buyingmonetary malfeasance insurance - which via certain asset classes can still beacquired for reasonable prices.RegardsStephen JohnstonLegal Notice: Copyright material, please do not re-use without consent. The opinions, estimates, projectionsand other information contained herein are not intended and are not to be construed as an offer to sell, or asolicitation to buy any securities, including any exempt market securities, nor shall such opinions, estimates,projections and other information be considered as investment advice or as a recommendation to enter intoany transaction. Please contact your registered investment adviser for information that is tailored to yourspecific needs.