The World's Governments Are Nearly Bankrupt: Now What?

For this article to make the most sense I would highly recommend watching this 30 minute video from Ray Dalio about the economy and debt cycles.

Spoiler alert: We are at the end of a long term debt cycle that has been extended twice through bank and government bailouts in 2000 and 2008.

…there is no one left to bail us out.

So What’s Happening?

Sovereign debts — debts owed by the government to bond holders — have reached a level that hasn’t been seen since the mid 1940s.

Quick history check, that’s when we were forced to print money to fight the nazis.

Explained simply, the central bank can do one of two things:

1. Raise interest rates and sell assets ‘owned’ by the central bank. (Reduces inflation)

2. Lower interest rates and buy assets from the open market. (Encourages economic growth)

The inflation that has arisen due to fiscal policy, energy shortages and supply chain disruptions has forced world governments to begin raising rates.

Why is This Time so Catastrophic?

Here’s the problem: The central banks can’t keep raising interest rates to fight inflation without breaking economic systems.

The Bank of England stepped in last week, in an emergency situation caused by interest rate increases and a weakening £GBP, that could have possibly resulted in as much as 90% of pension funds in the UK becoming insolvent.

Why?

National debt is too large for governments to pay back if interest rates get too high.

Let’s say I borrow $1000 from you at a 0.5% interest rate (rates before 2020). That means I need to pay you $5 at predetermined intervals.

That sounds fine to me, I can pay $5.

Now let’s say you increase the interest rate I owe you from 0.5% to 3.25% (rates currently).

My payment to you now becomes $32.50.

If I only made $30 in that time I won’t have enough to pay you back and default on my debt.

GDP is the amount of things produced by a country. But more importantly, the amount of things that can be taxed to generate income for a government.

Because of the ratio of national debt to GDP has become so high, governments will soon not be able to generate enough tax revenue to pay their version of $32.50 if interest rates continue to rise. G12 Countries have a combined debt to GDP ratio of 131%

The Way(s) Out

1. Deflation: “Countries go bankrupt”, widespread defaults as countries can’t pay treasury holders, endowments disappear (social security) and governments cut spending to non-critical areas.

2. Inflation: The central banks lower interest rates and print money in order to buy more assets (including government bonds so they can continue to operate).

Due to the fact that the results of the first choice in this hellish choose your own adventure novel are so bad, central banks in nearly every situation that has ever occurred choose door #2.

Stay tuned for another bonus distillation on some exact numbers, more explanation and forecasts for the next 6-24 months.