Who is Lending Governments Money?

Voters are at risk

A while back I was reading a financial article and came across an interesting question. If so many governments are deep in debt and broke, who is lending them money?

Does a sensible person lend money to someone who is going bust? Obviously not; so who or what is supporting the system?

The answer is very worrying. Banks lend money because they need an income, and that income is derived from loans. If a bank doesn’t lend out money, it no longer has an income. Customers keep money in a bank, and the bank pays them a pittance in return, but the bank then has to lend that money in order to pay customers and make a profit. It is also the case that banks have to have a certain amount of money invested in tier one categories, in other words, government debt.

Most people invest in pension funds. Where are those funds invested? In what are supposed to be safe assets; in other words, government debt.

So the next question is: what happens when a government does go broke?

There are two ways of looking at that scenario. Either a government will default, in which case the debt does not get repaid and the bank or pension fund loses its customers’ money, or the government devalues its currency, and so the debt gets repaid in seriously devalued money. Put another way, that means the lenders get shafted.

In other words, the lenders are ultimately members of the public, and it is those people who will get stuck with holding a bad debt that either doesn’t get repaid, or gets what is amusingly called a haircut. That is, the lenders may lose all of their money.

So, if a government screws up financially, you guys pay. Ultimately, that means your pensions get dragged in the mud. When you retire, you wont have anything to retire on.

Now let’s look at this scenario from the other side.

The traditional financial safe haven in the EU has been Germany. Sadly, the German economy is in tatters. It cant cope with the massive hike in energy costs, and that has trashed the country’s economy. That also means that Germany can no longer bail out a failing euro.

At the same time, Italy has a debt to GDP ratio of over 135%. That means the country as a whole is financially underwater. It doesn’t even take the average ten year old more than a few seconds to realise that is unsustainable. So the question then becomes: how long can such a situation be sustained?

The short answer is: Dont know! The realistic answer is: Not much longer. In real terms does that mean one year; two years; five years?

Now add in the situation of two more of the EU’s largest economies: France and Spain. Both are heading in the same direction as Italy. You now have the four largest EU economies that have a fiscal future that is realistically measured in months.

Where is this heading?

Let me add a few unpleasant facts from outside the EU.

The BRICS countries have introduced an alternative international payment mechanism that is being taken up by 185 countries. That’s over 80% of world trade.

The USA has run a trade deficit for the whole of the twenty-first century. So has Italy.

Let me put it this way. How long can the average family survive when they spend more than they earn?

The answer is simple: only until someone stops lending them money.

So the question now becomes: How much longer will banks and pension funds lend to governments that clearly have no way of repaying the money borrowed?

The tipping point is when debt to GDP rises above 90%. That’s when the costs of paying the debt start to put the debt up against par. That’s dodgy, if the next move is an increase in the debt, then there will be no equity left to cover future borrowings. So when a country has a debt to GDP value in excess of 100% lenders will be seeking that number to reduce. When it balloons even higher, that spells danger, and financial stability goes out the window. A rising figure beyond 100% means that either a country needs to make drastic adjustments, or the loan is no longer viable.

Here is the current list of EU countries with debt to GDP that is in negative territory, and getting worse:

Greece: 160%; Italy: 138%; France: 114%; Belgium: 108%; Spain: 105%, with Portugal teetering around 100%.

Now add in the fact that already two EU countries are going over to BRICS, and more are considering a similar move; and that the rest of the world is starting to use the new BRICS Bridge system for international trade. Now factor in one crucial problem: Western Europe is resource poor. The area has a large population, around half a billion people, and many of the countries have to import about 80% of their energy, food, and manufactured goods. That means they will be paying from a failing economic base to a successful economic base for essential survival goods. How long can a continent sustain that situation without falling into economic stagnation, quickly followed by deteriorating living standards? Europe already is suffering stagnation, or downright recession (0.7% increase over last year, which is probably a seriously massaged figure). How far in the future is the fall in living standards? I suggest that maybe 2026 is the year that sees the tip from one situation to the next.