First Greece, Now Italy, Who’s Next?: Analyzing The Sovereign Debt Default Chain

by: Nicholas Pardini
November 11, 2011

Starting in May of 2011, the extent of the global sovereign debt crisis began to hit the equity markets. Greece was first, then Portugal, then Ireland, and now Italy has become the focus of the financial markets and a source of macroeconomic weakness.

However, these countries are simply the first dominoes in a chain of fiscal crises that will either result in a series of defaults in the developed economies’ bond markets or high inflation generated by central bank intervention. The question now is who’s next? Countries with high debt/GDP ratios, high unemployment and lack high economic growth to sustain deficit spending are all about to face the consequences of reckless fiscal policies. Below I list the countries I believe to the most likely to enter sovereign debt crises of their own after Italy.

1) Spain: Spain has made some austerity reforms to address its problems, but the continued weakness of the Spanish economy will slide Spain back into fiscal trouble. Spanish 10-year yields have reached 5.9%, which is near its danger zone. The Spanish GDP has only grown at an annualized pace of 0.2% and is highly likely to slide back into recession. With a 21% unemployment rate (40% for those under 24), expect this to get worse with a return to recession. Continued high unemployment may also lead to civil unrest. The struggles of the eurozone will also diminish tourism to Spain which will compound the struggles of the Spanish economy. These signs are bad for the success of the austerity measures and will put the heat back onto Spanish bonds.

2) Belgium: The pending breakup of Dexia has confirmed Belgium as the newest member of the PIIG pen. Belgium has a debt to GDP ratio of over 100% and it does not help that the country has been without a government for 516 days. The country is going through a political crisis as this is the second time in four years when the country has been without a government for over six months. The French speaking Walloons and the Dutch speaking Flemish in the north are fundamentally divided and have more loyalty to ethnic identity than the Belgian nation. Slow growth and 3.55% stagflation does not help the situation.

3) France: Rumors of France’s loss of its AAA credit rating are eventually going to come to fruition as the market has begun to punish French bonds. Their spread versus the German bond is 1.69%, which is equivalent to the spread between Italy and Germany this time one year ago. France’s economy is growing faster than the PIIGs, but at 0.9% annually is still very slow and they have a high 81.7% debt to GDP ratio.

4) U.K.: The British economy is struggling through a stagflationary slowdown and the woes of continental Europe will put a strain on British exports. At just 0.5% GDP growth and 5.2% inflation before the Bank of England’s latest round of quantitative easing, it looks like the U.K. is already on its way toward inflating out of its debt (80% debt/GDP). The loss of North Sea oil and a lack of competitiveness outside of financial services leaves Britain in a vulnerable place economically. I expect the crisis in the U.K. to hit once the market is finished reacting to the debt problems of Italy and France. The best way for investors to play the possible British default (through honest means or inflation) is through shorting the British Pound.

5) Japan: At 220%, Japan has the highest debt to GDP ratio outside of Zimbabwe. Also demographic trends will significantly reduce local demand. As Japan’s largest generation is entering retirement, the smaller less economically successful younger generations of Japan will not be able to make up for the new shortfall of bond demand. Foreigners will demand much higher yields. Japan has been relying on near zero interest rates for 20 years to finance itself. Once yields rise, the market’s response to Japan’s struggles will dwarf Italy.

6) Germany: Germany is the wild card of the bunch. Its debt problems are not created by the faults of its own economy but its risk of being on the hook to finance the bailouts of the PIIGs. If Germany stopped supporting the weaker members of the EU and pulled out the eurozone, it could save itself from debt or inflationary crisis. Despite receiving objection from 75% of the German people, the political climate of Germany’s political elite is committed to preserving the euro at all costs. Going all in for the euro would sink Germany’s ship along with the rest of the continent. Even before any bailout of Italy, Germany’s debt to GDP ratio is already 83.2%, so time is running out for Germany to decide on its loyalty to the eurozone.

7) United States: The biggest domino in the sovereign debt crisis is right under our noses. It will also cause the most long term damage to the long term economy. The U.S. is the world’s largest debtor nation with (latest estimates) $14 trillion of debt (or 100% of GDP). Deficit spending is continuing at over $1 trillion of new debt per year. These numbers do not even include unfunded future liabilities related to social security, medicare and the bailouts of Fannie Mae (FNMA.OB) and Freddie Mac (FMCC.OB). Since U.S. tax receipts primarily come from income taxes over consumption taxes, tax revenue is more sensitive to economic fluctuations. As a result, persistently high unemployment will keep tax revenues down for the next several years. Half of U.S. borrowing is in short term T-bills. So once the Treasury has to refinance at higher rates, interest as a portion of the government budget will skyrocket. The U.S. Congress does not have the best record of making budgetary compromises or cutting spending, so expect the worst from any upcoming debt settlements. The solution they will ultimately use to solve this debt crisis will be through monetization. Once the euro mess resolves the best way for investors to hedge themselves will be through commodities, precious metals and equities that have pricing power.

8) Canada: Canada benefits from being a major exporter of raw materials, but weakness in U.S. (especially during its debt crisis) and Chinese economies will be devastating to Canada. In fact they may be even ahead of the U.S. on the path to a double dip recession with negative GDP growth for the second quarter of 2011. Canada’s debt/GDP is also high at 84%. Canada can print its way out of its debt problems, but bond holders will lose either way.

  1. #1 by limkamput on Saturday, 12 November 2011 - 3:35 pm

    Some of the countries like Germany and Japan are nations who created the problem on themselves. The world must learn to let debtOR nations or nations spending beyond their means to die, no rescue not bail out, as simple as that. Can’t you see there are nations whose economic function is just CONSUMING? You can’t be doing nothing but expect standard of living higher than countries whose citizens have to work their butt out.

  2. #2 by yhsiew on Saturday, 12 November 2011 - 4:03 pm

    One possible solution for nations in heavy debts is to allow their currency to depreciate (cheap sale), so that they don’t drag the world economy into doldrums.

  3. #3 by monsterball on Saturday, 12 November 2011 - 4:18 pm

    Don’t lump us with those countries.
    We have OIL..timber and palm oil.
    We will go bankrupt few years time…….but not now.
    UMNO b is still stealing.
    The wells are still having water…not dry yet.
    What a blessed country we have…spoil by crooks.

  4. #4 by TheWrathOfGrapes on Sunday, 13 November 2011 - 11:25 am

    The quote below was what I posted in the other thread:

    /// Before some smart alec comes along and say: “So what is the problem? Singapore’s public debt is 105.8% of GDP compared to Malaysia’s 52.4%.”

    Matthias Chang actually thought he has discovered some earth-shattering secret concerning Singapore’s national debt and published it on his website some time ago and screaming at all and sundry to short the Singapore Dollar. Don’t know whether that scoop is still on his website, but I pity those who followed his sure-win investment tip to short the Singapore Dollar – they must be hurting like hell right now.

    For those who do not understand Singapore’s financial strength, the CIA World Factbook will give a glimpse.

    Singapore’s public borrowing is largely to develop its debt and capital markets. It does not need to borrow for infrastructure development or consumption.

    The critical borrowing is the External Debt.

    Some numbers for comparison:

    Budget Deficit: 5.6% of GDP
    Public Debt: 52.4% of GDP
    External Debt: US$72.6bn
    Reserves: US$106.5bn

    Budget Surplus: 0.2% of GDP
    Public Debt: 105.8% of GDP
    External Debt: US$21.8bn
    Reserves: US$225.7bn

    note: for Singapore, public debt consists largely of Singapore Government Securities (SGS) issued to assist the Central Provident Fund (CPF), which administers Singapore’s defined contribution pension fund; special issues of SGS are held by the CPF, and are non-tradeable; the government has not borrowed to finance deficit expenditures since the 1980s ///

    Since then, I have found Matthias Chang’s article On 18 Dec 2009, USD1 = SGD1.40. Now, USD1 = SGD1.28. That is, instead of collapsing or depreciating drastically, the Singapore Dollar has appreciated by 9.3% since Matthias was screaming his head off to short the Sing Dollar.

    Thinking the Unthinkable: Singapore Sovereign Default – Time to Dump Sing Dollars – By Matthias Chang (18/12/09)

    By Matthias Chang
    Friday, 18 December 2009 11:29

    This article will annoy a lot of people, especially investors and the government of Singapore.

    But, a warning must be given as the year comes to a close and as we head into stormy financial waters in 2010.

    In an earlier article, I have warned that the 2nd Wave of the Global Financial Tsunami will hit us between the 1st and 2nd quarter of 2010. It could be earlier, but for sure it will happen in 2010. The signs are clear.

    2010 will be unusual and significant because the key factors that will trigger the 2nd wave will be sovereign defaults across major economies. The Dubai default is but a glimpse of what is to come in 2010.

    But, I am more concerned with events unfolding in South-East Asia.

    In the 1997/1998 financial crisis, the contagion started in Thailand and within months spread across the entire region, even affecting the so-called Tiger Economies. We, in Malaysia know too well the effect it had on our economy.

    The European Commission has sounded the alarm bells that some key economies are overly indebted and would pose a grave danger to the global economy.

    See for yourself. As a percentage of the GDP, the debts of the following countries are as follows: –

    1) Japan 172.1%
    2) Lebanon 160.3%
    3) Italy 105.8%
    4) Singapore 99.2%
    5) Greece 97.4%
    6) Belgium 89.6%

    East European economies are tottering at the edge of bankruptcy.

    Already, in the last few days, Greece is in turmoil and sovereign default is a real likelihood. IMF has weighed in on the issue and has demanded austerity measures, but Greece refuses to comply and remain defiant.

    If Greece is in a mess, what will happen to Singapore?

    Singapore has 99.2% of debt to GDP and its external trade has collapsed for good and will remain down and out for the near future, well into 2011 at the minimum. Singapore investment agencies have suffered substantial losses as a result of their dabbling in Wall Street’s toxic wastes. The monies in these investments are lost for good.

    If the global economy remains stagnant, as it will be in 2010 and 2011, Singapore is a candidate for default and this can happen anytime soon. And the contagion to the economies of South-East Asia will be devastating, especially to Indonesia and Malaysia. Compared to the situation in 1997/1998, the coming contagion will overwhelm our fragile economies.

    Many Malaysians who have made ill-gotten gains have parked their monies in Singapore, thinking that it is a safe haven. This is especially so for the rich and famous from Malaysia and Indonesia.

    They better get their money out quick and park it somewhere really safe – e.g. in China as when the shit hits the ceiling fan, you can bet that the Singapore government will clamp down all exits and no funds will be allowed to escape.


    You are forewarned.

    Get your money out of Singapore now! Dump Sing dollars!

    Is Malaysia ready for such an eventuality?

    Any responsible government must consider all probabilities and put in place strategies and policies to avoid the fiasco.

    I have heard from the grapevine that the political secretaries and special officers (especially those having a long list of alphabets after their names and with management consultant credentials) are not even aware that such an eventuality can occur in 2010 / 2011.

    Others at the Central Bank and Treasury are also in deep slumber.

    Sorry to spoil your Christmas and New Year holiday mood.

  5. #5 by Not spoon fed on Wednesday, 16 November 2011 - 2:28 pm

    National Inflation Association of US states massive inflation shall come. US has worse debt than Euro zone.

    Malaysia could be the next. Just a matter of time.

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