By Lance Crossley
Last month, I took a mid-year review of how I was faring with my 2010 prediction that states would face serious insolvency issues. We found evidence that this is indeed happening in the form of the Greek debt crisis as well as a number of other Euro nations that are dancing with precarious balance sheets. I said the theme of insolvency would also play out on the institutional level (with banks) and the individual level. Since I didn’t have space to address the latter two items last time, I’ll give it a go for this column.
The thing with debt is that you can’t separate government debt from bank debt or from individual debt; it’s all part of the same story. For example, last issue I mentioned one of the reasons for the bailout of Greece was to keep German and French banks, who were heavily invested in Greek bonds, solvent. French and German leaders feared a Greek default would render those banks’ assets worthless, and thus engender a run on their countries’ banks.
How much of a threat is the sovereign debt crisis for banks? A June 11 Bloomberg article reported that in a worst-case scenario – where Greece, Ireland, Italy, Portugal and Spain would all restructure their debt because of their inability to pay – banks globally would lose $900 billion dollars. In the past I have mentioned how the banking system is extremely over-leveraged. That means it would never have to reach a worst-case scenario to create another banking crisis. It would probably only take one or two countries to default to start the domino effect.
The debt crisis is also unfolding on the individual level. At the end of May, the Organization for Economic Co-operation (OECD) said in its semi-annual economic outlook that the debt levels among Canadian families threatens our economy. The report was overall quite positive on the Canadian economic recovery, but was quick to point out that “the high rate of household indebtedness is a source of risk to the outlook.”
The OECD report follows a similar warning from the Certified General Accountants Association of Canada, which said household debt in Canada is 2.5 times what it was in 1989 – that’s $41,740 per person! People just don’t have any rainy day funds anymore. When something goes wrong, they are really in the mud. The main asset Canadians hold is their homes. If housing prices begin to decline – as I believe they will – a lot of people will be without a financial lifeline.
The whole debt problem will eventually cause deflation. There’s no other way around it. What goes up, must come down. In that sense, my 2010 prediction wasn’t really a prediction at all. I was only observing a story that was already written during the many years of easy credit and loose monetary policy. What we are witnessing now is the story unfolding.