VCG Forex.com Blog

In the last few weeks investors have been reminded about the complications of credit and debt.  Markets around the world have once again declined in value to start the year.  This has surprised many, which is ironic as it was only 16 months ago when the financial world was brought to its knees by the credit and balance sheet issues.   But perhaps we can use this descent as an opportunity to address the fundamental truth; something must be done to fill the gaps.

Let's first recognize the complete problem.  At the end of 2007 there were collectively $100 trillion worth of debts worldwide on the books.  Those debts were secured by $50 trillion of assets at a ratio of 50%.  The trouble is that the asset base has shrunk because of declining stock markets, housing prices and real estate corrections.  If asset bases are reduced and the debt burden is not, you've got a real problem.

This is not the first time I've written about this issue.  As I noted early last year, to stop the economic bleeding governments around the world did the only short term things they could.  They aided the ailing institutions by assuming the sketchy debt the institutions created and couldn't dump on their clients and turned on the spending spigot.  While arguably necessary at the time, neither addressed the underlying asset gap and both contributed to the widening.

Leave it to the masters of finance to pull off this coup, but the fact of the matter is that the failing and insolvent banks used their influence, political connections and fear mongering tactics to pressure governments worldwide to grant them a clean slate.  People can moan about this all they want but it doesn't change the reality that those inadequately financed loans have now been transferred onto the balance sheets of their respective governments.  If that wasn't a big enough challenge, those further leveraged governments simultaneously implemented spending programs to promote economic growth.  Given the performance of many markets so far this year, maybe the day of reckoning is upon us.

In my January, I predicted that risk would be a factor this year as several countries fail to roll their debt.  This happened sooner than I expected as Greece, Portugal and Spain are the headliners right now.  Government spending and balance sheet issues are now the factors that lenders of the world (bond purchasers) are considering as numerous nations come to the market to finance their inadequacies.   But given low government interest rates, balking by bond buyers should come as little surprise.

Even with all the market fear, interest rates in these three countries remain very low.  (Ten-year bonds yield just 6.25%, 4.41% and 4.03% respectively in Greece, Portugal and Spain).   It's a wonder why anyone would take on such default risk for so little return.  But when further examined, it becomes apparent that this is a global issue and the reason why their rates remain so low is that there are very few better alternatives.

One way to examine sovereign debt risk is to look at the spread over treasuries.  Remarkably, the largest spread over 10-year Treasuries that any of these countries face is 2.25%, born by Greece.  To me this is the market saying that these spending and indebtedness issues are worldwide and that the U.S. is not immune to this virus.

It doesn't take much work to find out how whacked our budget is here in the U.S.  There is simply way more government spending than there is tax revenue and it's been that way for a long time. The maddening solution to date has simply been to pile debt upon debt.  It's politically easy to simply raise the debt ceiling.  But a few facts and a couple of recent events lead me to believe this game is close to over.

First off, the numbers published by many U.S. government agencies are as manipulative as they are vast. They have implemented accounting tricks that would make Lehman Brothers blush.  The truth is that our total debt is currently 85% of GDP and will be 100% of GDP by 2012.  These types of numbers are making those Euro countries I mentioned teeter.  Moreover, about 50% of our debt is owned by foreigners.  If you want an example of how big a problem that is than look no further than Fannie and Freddie.  The majority of their quasi government debt at the time they went into conservatorship was owned by Japan and China.   There was no way those two countries would have accepted default.  And what happened?  They forced Fannie and Freddie into taxpayer hands and they have now amassed $1 trillion of losses that Americans will be paying for years.  Also of note is the fact that the first few treasury auctions of the year are failing miserably.  They have been less than 25% subscribed as no one is willing to buy our debt at these paltry rates.  To make matters worse, China was a net seller of treasuries in December as it unloaded $34 billion of its holdings.  It's time to wake up and accept the fact that the forces pressuring Greece are now surrounding our borders. So, here's what can be done.

To fill the asset and revenue gaps we can raise taxes, reduce spending or create more currency.  You can make your own assumptions as to the likelihood of the first two occurring.  But I think the third option is either being overlooked or undeservedly dismissed.

Most economists I've consulted say that you can't print your way out of debt or to a balanced budget because it will destroy the value of the underlying currency and create inflation.  But recent history contradicts as the Fed has increased the money supply (USM1) by 22% in the last two years and the dollar's index value is the same as it was in the middle of 2007.

I will, however, confess that printing more money should cause inflation.  And that's the beauty of this plan.  If we turn on the presses we can buy our own debt while we simultaneously increase asset prices.  Genius!

I realize that some of my ideas sound farfetched. But given the state of economic confusion, we are in dire need of some off the wall ideas.  I also take solace in the fact that several of my past suggestions have now been implemented in some form or fashion.  However odd it sounds, printing our way to solvency is an option that plugs holes.  And part of my duty as a citizen, money manager and author is to find a way to fill the gaps.

Joseph Warren is founder and CEO of Warren Capital Group.  Warren Capital Group is a SEC Registered Investment Advisor providing investment management and advisory services.  WCG has expertise in the areas of stocks, bonds, real estate, money markets and other alternative assets.  Learn more about Joseph Warren and Warren Capital Group at http://warcap.com or email at jrw@warcap.com.