Greece’s debt troubles are well known. Less recognized is the worrying truth that Greece is just the tip of the iceberg.

There have been plenty of warnings. These include, for example, the recent downgrades of the debts of Spain and Portugal. By highlighting the risks, the debt rating agencies have sent a signal with one certain outcome. Heightened awareness over sovereign credit risk will grow, and rightly so.

A report released just last month by the Bank for International Settlements, entitled “The future of public debt: prospects and implications”, made some startlingly frank and sobering conclusions. The BIS report began earnestly:
http://www.bis.org/publ/work300.pdf

“Since the start of the financial crisis, industrial country public debt levels have increased dramatically. And they are set to continue rising for the foreseeable future.”

After a through and well-researched analysis complete with detailed documentation, the BIS walked carefully through this political minefield, no doubt aware the slightest misstatement would leave it open to rebuke by its benefactors, the countries and central banks that fund its operation. But hats-off to the BIS. It left no doubt as to where it stands on this matter by concluding with the following stark assessment.

“First, fiscal problems confronting industrial economies are bigger than suggested by official debt figures…As frightening as it is to consider public debt increasing to more than 100% of GDP, an even greater danger arises from a rapidly ageing population. The related unfunded liabilities are large and growing...In the aftermath of the financial crisis, the path of future output is likely to be permanently below where we thought it would be just several years ago. As a result, government revenues will be lower and expenditures higher, making consolidation even more difficult…

Second, large public debts have significant financial and real consequences. The recent sharp rise in risk premia on long-term bonds issued by several industrial countries suggests that markets no longer consider sovereign debt low-risk…

Third, we note the risk that persistently high levels of public debt will drive down capital accumulation, productivity growth and long-term potential growth…

Finally, looming long-term fiscal imbalances pose significant risk to the prospects for future monetary stability...unstable debt dynamics could lead to higher inflation: direct debt monetisation, and the temptation to reduce the real value of government debt through higher inflation.”

Please read that last paragraph again about the significant risk to monetary stability. In other words, governments will not cut spending and bring their budget back into balance. They will simply lean on their central bank to print and print and print. Everyone holding sovereign paper will get their euros and dollars and pounds repaid to them, but those currencies will have only a fraction of their present purchasing power. The rest will have been inflated away.

I have always wondered why people – after paying 40% or so of their income in taxes – then put what they manage to save in government paper. Further, it always struck me as somewhat bizarre that they then call the paper they purchased “risk free”, even though nothing in our real and imperfect world comes without risk. It is a conundrum with only one explanation – it is irrational. All of us have seen this behavior before.

It is the behavior that sent the unthinking crowds into Internet stocks. It is the behavior of unthinking people who bought second and third homes and condos with debt in the expectation of flipping them with a huge profit to someone else. It is the behavior of unthinking bankers who piled into mortgage-backed securities believing that the triple-A rating meant the paper came without risk. The common characteristic of all these manic episodes is that they are the actions of people acting with a ‘bubble mentality’. They are not guided by rational thought, but unthinking and emotional knee-jerk reactions. And the same is true today with sovereign credit risk, but with a difference.

The other examples are past history. The so-called “risk-free” sovereign debt bubble has only recently begun to pop.

The signs are all around us. Iceland, Dubai, Latvia, Greece with Portugal and Spain not far behind, and the UK and even the US and most every other country on the not-too-distant horizon. The sovereign debt crisis – which is actually a latent bank crisis because banks are stuffed full with the worthless paper of over-indebted sovereigns – is a powder keg, and the fuse has already been lit. So what should we do? What can we do?

The answer is simple. Own physical gold instead of someone’s promise. Its time-proven record built up over the centuries clearly illustrates that gold is the ultimate safe haven. Gold is the best way to avoid counterparty risk, which is essential today as the sovereign debt bubble continues to lay bare the stark reality that governments throughout the world are bankrupt, and more to the point, that the bubble has popped. People holding sovereign paper are already heading for the exits. As a result, everyone needs gold now more than ever.

Glorieux