Petrocapita Update (continued)
My reason for shamelessly plagiarizing old material isa belief that these critical issues that we face in thewest remain largely unaddressed - worse yet manyare actually growing. As such they are worth anotherlook if only to act as counterpoints to the inevitableavalanche of “bullish, equity centric, long only”analysis that invariably emanates from the banks,mutual funds, and the mainstream nancial media atthe start of every new year.
THE FINANCIAL SECTOR HAS NOT BEENSTABILIZED
By subsidizing failure and creating even greatermoral hazard the bailouts will increase the amountof mispriced risk in the system - not reduce it. Thenancial sector has barely begun the process of recognizing and accurately provisioning for existinglosses. Examples of large yet mostly ignoredexposures abound. Here are just two:– Commercial real estate debt– Non-sovereign, government debt - e.g. municipalbondsRest assured that current low interest rates will createa host of new problems. Problems that are likely toarise on a scale and in ways that we cannot foreseetoday - the law of unintended consequences willnot be denied. Ask yourself what unsound risks arebeing taken on to bank, hedge fund, corporate andpersonal balance sheets today because long-termfunding rates are under 3% in many cases?
WESTERN GOVERNMENT BALANCE SHEETS ARE SERIOUSLY IMPAIRED AND DETERIORATING
EU and US net liabilities add up to around $135trillion - approximately four times the capitalization of the world’s equity markets. On top of this mountainof existing liabilities, scal decits are now risingnothing short of spectacularly. The US federal decitis now over 10% of GDP. These are the worst levelssince WWII for the US. By comparison, the US decitin 2007 was around 2% and peaked at around 4%during the inationary 1970s. Such massive debtscan probably only be repaid with some combinationof ination, tax increases and/or forced austerity -with the smart money betting on ination.
CENTRAL BANKS ARE MONETIZINGGOVERNMENT DEFICITS
By printing money to buy distressed assets, centralbanks are monetizing government decits. Themechanism is simple - recipient banks take thenewly printed money they receive in exchangefor their badly impaired assets and buy sovereigndebt. Indirect monetization to be sure, but moneyis fungible so monetization nonetheless. I wouldalso argue that this monetization is an explicit policyobjective. Don’t believe me? Here is a summary of some recent central bank printing activity:– The Bank of England printed £200bn = 2009 UK government decit.– The US Federal Reserve printed $1.25 trillion =2009 US government decit– ECB printing €750 for Greek bailout = 2009 EU27 government decit