Regular readers of Gold Goats ‘n Guns know that I’ve been handicapping a major sovereign debt default to begin here in 2018 or early 2019. But, what do I mean by that?
How does a sovereign debt default come about? And who will default?
There are a staggering number of factors that feed into this thesis but, for me, to keep it simple it comes down to five important trends coming to a head at the same time.
I call them the Five Pillars.
#1 Massive Foreign Corporate Debt
After ten years of ‘experimental monetary policy’ which drove borrowing costs in U.S dollars down to record lows, foreign companies still reeling from the after-effects of the 2008 financial crisis borrowed trillions of dollars to fund the global expansion of the past few years.
That debt pays investors in US dollars.
But, foreign companies tend to book revenue in their local currency.
A falling local currency makes dollar-denominated debt more expensive to pay off.
This leads to the next Pillar…
#2 Quantitative Tightening.
QT is simply the opposite of QE, Quantitative Easing. QE expanded the stock of dollars. QT is contracting it. This is what is fueling a rising U.S. dollar. This, in turn, is making it harder for foreign companies to keep up with their bond payments.
They are forced to sell, aggressively, their local currency and buy dollars in the open market.
This is why the Turkish Lira is in serious trouble, for example.
That puts pressure on the country’s sovereign bond market. Since a falling currency lowers the real rate of return on the bond.
Falling currency, falling bonds, Turkey will put on capital controls next.
This feeds into the next Pillar…
#3 Political Unrest in Europe and Emerging Markets
Smaller markets are more vulnerable to runs on their currencies because they already are considered high-risk investments. Hot money chasing easy profits goes in and comes out just as quickly when policy changes.
But, what I’m handicapping isn’t another Asian Crisis like 1998 where Russia and Thailand were the epicenters of default.
No, today, what’s happening in Turkey is a taste of what is happening in the European Union. Political unrest is everywhere. The U.K. over Brexit Betrayal. Germany and Italy over Migrants. Poland and Hungary are challenging EU authority over what’s left of their sovereignty.
Spain still has a couple of secessionist movements simmering below the headlines.
Confidence in national institutions’ ability to weather these storms is what drives investor decisions. Right now, the European Central Bank still has some credibility with investors, who believe Mario Draghi when he says he will do whatever it takes to safeguard the euro.
But, what happens when Draghi is...