Greece and Puerto Rico: Previews of Coming Attractions
Governor Alejandro García Padilla of Puerto Rico said this week he does not think the Commonwealth will be able to pay back the $73 billion in debt owed to bondholders. I find this rare bit of honesty totally refreshing. For the past three years some had speculated about the possibility of a Puerto Rican default, but most believed it to be a farfetched notion. Now the question of solvency is no longer in doubt: Puerto Rico is officially broke and is unable to pay all of its debt obligations.
The White House has firmly attested that a Puerto Rican bail out is not in the cards. The U.S. territory is requesting that the Federal government allow them access to chapter 9 bankruptcy, like Detroit used when it was unable to pay its bills. At the moment, only cities, towns and other municipalities are able to declare bankruptcy.
Like Detroit Michigan in 2014 and Stockton California in 2013, we can choose to look at Puerto Rico as an isolated incident. A blip on the debt radar that will only affect Puerto Ricans and about half of all municipal bond funds.
We can continue to delude ourselves into believing that Puerto Rico doesn't make a larger statement about the solvency of municipalities around the United States; or even the solvency of the United States in total. Investors can just view this as another buying opportunity; much like they were convinced the Country Wide Credit and Indy Mac bankruptcies provided a great buying opportunity. Because, after all, wasn't the real estate crisis supposed to be contained within the realm of just the 1% sub-prime mortgage borrowers.
But before investors mistakenly press the buy button once again they have to realize that P.R. is simply emblematic of a much larger problem. Puerto Rico is not an anomaly, it is more likely to be the "Bear Sterns" of the inevitable municipal debt crisis in the United States.
And then we have Greece. One thing is clear: Greece will default either through restructuring or debt monetization. The Greeks can remain in the European Union and submit to the austerity dictated to them by their German masters; or they can opt for self-imposed fiscal and monetary disciple under their own currency. In either case, this is a nation with a debt to GDP ratio north of 170%, and which suffers from sharply contracting revenue growth. Chaos and default in Greece is unavoidable; but is best dealt with on its own terms.
And as the rest of the world gawks at Greece and Puerto Rico's economic misfortunes, what they fail to realize is that China, Japan, Europe and the United States aren't that much different.
First let's take Japan, one of the top economies in the world, whose debt is quickly approaching 250% of its GDP. If there was any question if Prime Minister Shinzo Abe's three Kamikaze arrows would be successful at saving the flailing Japanese economy, this week's industrial output should provide the clear answer.
Japan's Industrial output fell in May at the fastest pace in three months, the 2.2 percent decline in output compared with the median estimate for a 0.8 percent drop. This added to fears the economy may be once again be in contraction mode in the current quarter. The irony is that one of Abe's Arrows sought to destroy the Japanese yen in order to spur exports and economic growth. But Japanese GDP is lower today than it was back in 2010.
The United States is not much better. After seven years of zero interest rates and unprecedented debt monetization, our National debt load ($18.3 trillion) stands at 103% of our phony GDP. In the first quarter of 2015 the US economy contracted by 0.2% and growth is predicted to be around just 2% in Q2-- making growth at or below 1% for the entire first half. The additional $8 trillion in publicly traded debt piled onto the nation following 2007 was supposed to lead to economic nirvana, not a perpetual economic stupor.
And then of course we have China whose market, despite massive government and Central Bank manipulation, has officially entered into bear market territory. Even with recent losses, the Shanghai Composite has surged 25% this year, and the Shenzhen Composite is up 67%. This stock market boom runs contradictory to the slowing pace of growth, which is at its weakest pace since 2009; while corporate profits are actually lower than they were a year ago.
This means exuberance for Chinese stocks isn't backed up by fundamentals. Instead, it appears markets are being levitated by continued government borrowings and manipulations--both of which seem to have lost their magic over the past few weeks.
But the greatest bubble of all is the fairy tale that Central Bank money printing can lead to economic prosperity. The credibility of central banks' to push asset prices and GDP inexorably higher through endless debt monetization is fading fast. The ugly truth is that debt in the developed world has now grown to such an excess that it has to be restructured or monetized.
This is why there isn't an honest bond market left in the world. It is why the Bank of Japan is buying every Japanese government bond issued. And why the People's Bank of China keeps cutting lending rates and reserve ratio requirements to prop up its ailing economy and bubble-addicted stock market. It's also why the European Central Bank pledged "to do whatever it takes" to keep sovereign bond yields from rising-even in Greece. It is also the sad truth behind why the Fed seems unwilling to raise interest rates higher than zero percent...even after seven years.
These central banks are aware that once interest rates rise the whole illusion of solvency vanishes and the entire developed world will look no different than Greece and Puerto Rico does today. Once interest rates normalize, which is inevitable, these nations will undergo an explosion in debt service costs just as their bubble economies implode; causing annual deficits to skyrocket out of control. Therefore, unfortunately, a worldwide deflationary depression and/or intractable inflation have now become our unavoidable fate.