The sovereign debt crisis that has been brewing for the past few years is the most critical economic crisis the world has ever faced. We are a few bad decisions from total and global economic collapse – the great reset, as they say.
Our fate rests in the hands of the same political elites that helped
create the problem in the first place. We are trapped in an economic
quagmire. This really could be it folks. It may only be a matter of time
until we meet a fate worse than that experienced after Lehman Brothers
brought the banking system to its knees in 2008.
The post-Lehman collapse was bad, but today the problem is far worse –
it is far more fundamental to the global economic system. Lehman
Brothers sent the financial system reeling because the trust behind tens
of thousands (if not more) of financial contracts evaporated. Nobody
knew if their counterparties would exist in a week so they everyone
pulled funds from everyone.
Investors reacted by parking their money in the safety of cash and US
Treasuries. (Recall that at one point the yield on T-bills went
negative!) Central banks reacted by guaranteeing pretty much everything
and providing cash in exchange for any piece of collateral that wasn’t
nailed to a wall. Governments reacted by initiating mind-blowing fiscal
During the 2008 crisis, one assumption held true: the US dollar and
US Treasury Bonds/Bills were the gold standard in risk-free assets.
Expanding beyond the United States, during the crisis there was little
doubt in any investor’s mind that most G-10 sovereign bonds were safe.
Today’s crisis is much worse than that of 2008 because the
credibility of the sovereign is in doubt. This means that the $70
trillion in G10 sovereign debt backing the hundreds of trillions of
dollars in derivative contracts and financial sector liabilities is in
Despite the sheer size of the affected assets, this is not the origin of the issue. The fundamental problem is that these sovereign debts were once viewed as ‘risk free’, and thus formed the basis for financial collateral and asset pricing.
Consequently, a global banking system built on the assumption that the
foundation of a strong balance sheet is made of G-10 government bonds
will need to be re-thought.
Fundamental financial models and contracts (including the hundreds of
$trillions in derivatives) will need to change. Unfortunately,
widescale re-evaluation within the financial sector tends to be
characterized by a ‘shoot first and ask questions’ mentality.
Accordingly, the transition period during which global markets re-define
asset risk classifications and adjust contracts could result in
systemic financial collapse.
Making things worse, public sector debt crises can have a
pro-cyclical effect on economic deterioration. As government debt is
re-rated, so too are the financial intermediaries that own government
debt. The deteriorating financial sector has wide-ranging real economic
impacts, affecting government tax revenues, thereby eroding government
As G-10 banks have been party to financial repression, where they are
more-or-less forced to buy government bonds, one wonders if they have
any choice but to ride the sovereign debt crisis until the bitter end,
unable to adjust to the new definition of ‘risk-free’.
One thing is certain, a deteriorating financial sector only worsens
the sovereign debt crisis resulting in a spiralling collapse.
Unlike the post-Lehman collapse, a crisis that starts with the
sovereign cannot be solved by the sovereign. The 2008/2009 crisis was
halted because of combined epic monetary and fiscal stimulus,
facilitated through the captive banking sector. Today, most if not all
governments are effectively prohibited from more fiscal stimulus. Even
austerity has proven to be a failure for most. Without credible
government treasury departments to backstop endogenous sovereign debt
crises, the world may be set for a fate worse than the post-Lehman
With government treasury deparments out of the picture, the current
sovereign debt crisis, which will eventually travel from Europe to Japan
to America, can only be alleviated by massive monetary action to
recapitalize banks, keep real interest rates low/negative, maintain
steep yield curves and prevent a deflationary collapse. (Of course, this
assumes that preventing a deflationary collapse IS a good thing. I’ll
save that discussion for another day.) However, QE, QE2, LTRO and Twist
have demonstrated that marginal returns on monetary stimulus may be
shrinking, as the afterglow of each action has vanished at increasing
This leaves policy makers with two options: 1) Continue to little and
hopefully muddle through the crises; 2) Gear up the printing presses
until they run fast enough to make a dent.