Pricing Disaster

The world's largest debtors are facing the price of their borrowing habits.  The price is disaster--for citizens left victims of excessive government borrowing.

Investors trade mountains of paper every day with a price: that price is what people are willing to pay, given their best estimates of information they possess now, and what alternatives they may have.  It is not the price when the paper was issued, not when it will "mature", not when times will better, nor when times will be worse.  It is what people must pay today to own the paper today, and what people who are selling the paper must accept as the best they can get.

Such obvious facts are potent, particularly when doing the math on default.  Today the world's third largest issuer of paper known as bonds is Italy. Italy has bonds outstanding of $2.6 trillion--and Italian bonds are in trouble. That means buyers are not willing to own them today unless they receive high compensation--higher than any other recent time, perhaps higher than Italian citizens can afford. The compensation buyers of these bonds are demanding is a yield that is steep-- 6.7% annualized, to be precise. That is today. Now. And it is a disaster.

Why? Because if Italy had to pay that yield on ALL of the money it owes it would sink--and it probably will.  It owes more than 120% of its national economic output in bonds, and that does not count promises it has made (outside of paper bonds in circulation) to retirees and public employees. Just on its paper bonds, financing at current rates will consume more than 8% of Italian national income FOR INTEREST ALONE (assuming Italy had to refinance all its obligations today). The principal is growing too, as the Italian government runs deficits of 5-7% of its national output each year, adding to the burden that must be financed in the future.

If the Italian population were young, vibrant, and clamoring for reductions in the size of its government, this might be a salvageable situation for them--but they are not.  They are old and getting older as a group, with none of the faith in their future that characterizes high-growth, youthful opportunity.  They don't have many children.  They don't have strongly competitive industries.  Like many other troubled western economies, they have reached their tipping point, and will almost certainly tumble into broken promises of huge size, most likely default.  

As big as Italy's broken promises will be (however Italy chooses to break them), they will be small in comparison to others we will see very soon.  Japan has debts a  multiple of Italy's, and an older population, with even fewer children. Though Japan has some very competitive industries, it too faces a severe crunch should rates rise on its debt.  

The granddaddy of them all, however, is our own Uncle Sam.  Our country is the king of all debtors, with bonds outstanding of $15 trillion, now 100% of our national output (again excluding non-bonded promises for such non-trivial things as future Social Security, Medicare, and state/local debts). The US government took in $2.2 trillion in tax revenue last year, but the "new normal" spending addiction of $3.7 trillion of "essential" annual outlays is adding 10% to our debts each year.  We borrow 41% of every dollar our government spends, and it is our fourth year in a row of doing so.

The price of disaster for Italy--6.7%--is flashing now.  For the US the price may well be lower, due to our enormous outstanding debts. The time for breaking promises is now for Italy, whether they like it or not.  For the U.S.--and the rest of the world--our citizens must realize that we, too, will endure many broken promises, even disaster, without ending the madness that is our government's relentless spending. Whether we like it or not.

The world's largest debtors are facing the price of their borrowing habits.  The price is disaster--for citizens left victims of excessive government borrowing.

Investors trade mountains of paper every day with a price: that price is what people are willing to pay, given their best estimates of information they possess now, and what alternatives they may have.  It is not the price when the paper was issued, not when it will "mature", not when times will better, nor when times will be worse.  It is what people must pay today to own the paper today, and what people who are selling the paper must accept as the best they can get.

Such obvious facts are potent, particularly when doing the math on default.  Today the world's third largest issuer of paper known as bonds is Italy. Italy has bonds outstanding of $2.6 trillion--and Italian bonds are in trouble. That means buyers are not willing to own them today unless they receive high compensation--higher than any other recent time, perhaps higher than Italian citizens can afford. The compensation buyers of these bonds are demanding is a yield that is steep-- 6.7% annualized, to be precise. That is today. Now. And it is a disaster.

Why? Because if Italy had to pay that yield on ALL of the money it owes it would sink--and it probably will.  It owes more than 120% of its national economic output in bonds, and that does not count promises it has made (outside of paper bonds in circulation) to retirees and public employees. Just on its paper bonds, financing at current rates will consume more than 8% of Italian national income FOR INTEREST ALONE (assuming Italy had to refinance all its obligations today). The principal is growing too, as the Italian government runs deficits of 5-7% of its national output each year, adding to the burden that must be financed in the future.

If the Italian population were young, vibrant, and clamoring for reductions in the size of its government, this might be a salvageable situation for them--but they are not.  They are old and getting older as a group, with none of the faith in their future that characterizes high-growth, youthful opportunity.  They don't have many children.  They don't have strongly competitive industries.  Like many other troubled western economies, they have reached their tipping point, and will almost certainly tumble into broken promises of huge size, most likely default.  

As big as Italy's broken promises will be (however Italy chooses to break them), they will be small in comparison to others we will see very soon.  Japan has debts a  multiple of Italy's, and an older population, with even fewer children. Though Japan has some very competitive industries, it too faces a severe crunch should rates rise on its debt.  

The granddaddy of them all, however, is our own Uncle Sam.  Our country is the king of all debtors, with bonds outstanding of $15 trillion, now 100% of our national output (again excluding non-bonded promises for such non-trivial things as future Social Security, Medicare, and state/local debts). The US government took in $2.2 trillion in tax revenue last year, but the "new normal" spending addiction of $3.7 trillion of "essential" annual outlays is adding 10% to our debts each year.  We borrow 41% of every dollar our government spends, and it is our fourth year in a row of doing so.

The price of disaster for Italy--6.7%--is flashing now.  For the US the price may well be lower, due to our enormous outstanding debts. The time for breaking promises is now for Italy, whether they like it or not.  For the U.S.--and the rest of the world--our citizens must realize that we, too, will endure many broken promises, even disaster, without ending the madness that is our government's relentless spending. Whether we like it or not.

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