Monday, August 2, 2010

The European Debt Crises

Mass defaults coming in Europe ! The first Greek city just defaulted on its debt.
The debt level is at dangerous levels in the developed world. It looks like European countries and banks are most exposed, but also US and Japan are indebted heavily. Here is an overview of their debt levels:                                                                                                                                               

A close look at the US:

History of defaults:

And it is not the first time sovereigns default, is history repeating itself again ? Here is an overview of how the sovereigns have behaved in the past:

Source: Reinhart & Rogoff

The above charts shows the previous waves of sovereign defaults. The coming wave of defaults will most likely be the biggest one since the French Revolution.

The above chart gives an overview of the history of defaults among European nations.

A close look at the debt level in selected countries
The debt level in the developed world is still rising and thus increasing the danger going forward.

 European countries are in a very difficult situation and this time they might not have any easy escape route. The most used escape route in the past for sovereigns has been inflation. However, this may not be possible this time. During former crises most of the bond holders have been passive and accepted a return less than inflation. This time there is the risk that the "professional" investors dump their bond holdings creating a very high interest rate level and hostile environment which could unravel nations.
Mass bankruptcies coming for European banks:

The forced austerity that is taking place in Europe will push most banks in the region into the abyss. When banks begin to fail, what will the governments do ?

See our earlier article "Risk in the worlds banking system" from October 2009 here regarding restrictions that we forecasted and are being implemented now.


Source: Bloomberg

The table above shows the leverage ratios for European banks which has reached extreme levels and are probably close to burst into mass bankruptcies. The German banks are for all practical purposes not able to meet their obligations unless the state of Germany continues to keep them alive.
Most countries in Europe are indebted beyond their means and cannot help their banking system. The only resourceful countries which can contribute are China, India and Brazil. It is doubtful that these countries are going to save Europe.

Greek bank collapse will crush Eastern Europe, Bulgaria and Romania will be among the hardest hit
The first Greek city, Pireaus, has just defaulted on its debt, see the story in Business Insider Money Game here. Who is the most exposed to this default see an overview here.
Other European banks and countries are also exposed. Bulgaria and Romania rely on Greek banks for a large amount of lending, much of which will be cut. There are others who will be effected, read the above articles for details.

An indebted Europe in a long term demographic decline

The danger today, as opposed to prior deleveraging cycles, is that the deleveraging is being attempted in the face a structural demographic downwave as opposed to population growth.
From a demographic point of view, Europe's (incl. Eastern Europe) spending wave has topped relative to the rest of the world, the peak was around 2007-2008 and that the trend will be down until 2024-2025. In the coming years the number of the retired and the disabled will rise to unmanageable levels. Europe, and Russia are expected to lose more than 30% of their population during the next several decades. See the details in our article "Global Forecast 2009". This means declining property values and more losses and stress for the banks.

The above is an extract of our investment newsletter published 30th of July 2010. See more about other financial markets in our latest ElliottWaveTechnicians July 2010 Investment Newsletter.

Geir Solem
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