Sovereign

Opening line to Alan Kohler's latest article in Business Spectator. Spot on!

At its heart, the global financial crisis is morphing from a credit crunch/real economy feedback loop into a problem of sovereign risk, and unfortunately there are few signs that politicians actually understand how much trouble we’re all in yet.

What Mr. Kohler is saying is that each government is trying to bailout its own economy simultaneously. The real danger is all this borrowing can't be repaid and that some major global economy is going to end up like Iceland.

I have always assumed the economy and currency to break first will be the US. It is borrowing more than it can repay. It was already running astounding deficits in the "good times" a legacy of the worst adminsitration in the Western World. The deficits under the Obama administration beggar belief! Those lending to the US now will not be repaid and although the default is unlikely to be de jure, it will be de facto. Firstly, default will occur via the rapid decline in the relative value of the currency and secondly through concomitant inflation that will accompany a substantial decline in the US exchange rate.

China, as the US's chief creditor is going to end up booking an unimaginable loss on its US treasury and currency holdings. It's playing a game of chicken and riding in both cars.

What the US really needs is to liquidate the excesses from its financial system, book the losses in its banking sector and commence the process of rebuilding its savings and capital base.