Tuesday, April 17, 2012

California or Spain: Who Will Default First?

Just one month ago, Greece defaulted on its debt as the size of the Hellenic nation’s sovereign debt obligations rose to more than 170 percent of 2011 gross domestic product (GDP). With the U.S. debt climbing to more than 90 percent of GDP in 2012, Standard and Poor’s downgraded U.S. debt last year.

But contrary to the case of our European brethren of Portugal, Italy, Greece and Spain, often referred to as the PIGS, investors actually unloaded debt of the PIGS and bought more tainted U.S. debt. It has been said that the U.S. debt won the “ugly” contest. U.S. debt is ugly, European debt is even uglier. So why is U.S. debt less ugly?

The fact is no European nation can print more money (Euros) in order to repay debt with depreciated currency. The European Central Bank controls the Euro value and has said emphatically “no” to this indirect rescue which also has the added impact of stimulating exports. On the other side of the Atlantic, the U.S. Federal Reserve (Fed) can, and has, turned on the printing presses reducing the value of the dollar and diminishing the burden of the U.S.’s inflation adjusted debt. Investors understand this and expect the Fed to continue this dollar depreciation “program.”

In summary, investors recognize that debt obligations are significantly more burdensome to governments that have no control over their money supply. States like California and Illinois with pension obligations of $240 billion and $139 billion, respectively, are the Yankee version of Greece. Unless they secede from the U.S. and adopt their own currency, they will tax their citizens more heavily, default on their bonds, renegotiate the pension obligations, or seek a federal solution (bailout).

Just as Germany and France bailed out the PIGS, Iowa, Kansas, Nebraska, North Dakota and South Dakota, with relatively small future pension obligations, will likely bail out their more profligate spending neighbors in the years ahead.

Ernie Goss

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