Tuesday, March 10, 2020

Imminent Sovereign Debt Implosion

Sovereign debt has been bid these past couple of weeks. The idea is that government issued bonds are safe. However, this misses the point that sovereign debt derives its ultimate value from the government's ability to levy taxes on its subjects. If this ability is reduced, the debt cannot be sustained. It will be defaulted on, either through monetary inflation, or through outright default.

Countries, such as Italy, with high levels of debt combined with a serious disruptions to their industries, are prime examples in this respect. There's no way Italy will be able to honor its debt through this crisis. It will either default right out, or it will ask the ECB to buy its debt with freshly printed Euros. Either way, there will be losses carried by bond holders. As a consequence of this, Italy's sovereign debt is already falling in value. A crisis in Italy's sovereign debt looks imminent.

But things will not be contained to Italy. Most western governments are currently heavily indebted. None of them will make it through a major recession without a hit to their sovereign debt, and with one country after another getting into trouble, the whole edifice of over-leveraged government structures is likely to crumble. Interest rates will explode higher, especially at the long end where central banks have little leverage. As a consequence, gold will head higher.

Those currently chasing sovereign debt will realize their mistake. The paper promises they are holding are going to go down in value. There will be a rush for the exit, and a bid for gold as the only true safe haven asset. This will in turn spark sharply higher interest rates on long dated papers. If central banks try to stop this by buying the long dated papers in order to suppress the spike in interest rates, their freshly printed currencies will only stoke the bid for gold. While money printing may keep interest rates from going exponential, it cannot at the same time keep gold from going higher. There is no way to avoid the coming reevaluation of sovereign debt relative to gold.

Changeur juif - Tunisie - avant 1910.jpg

By Unknown author - own archive, Public Domain, Link

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