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Which Nation Will Default Next?

By: Steve Johnson

12/17/2009 - 26 Comments

Contrary to the media cheerleaders that the recession is over, a deeper look at the world economic picture reveals that much darker clouds are on the horizon.

As nations become unstable, their currencies are becoming unstable.

The economy crisis is moving from a banking and finance crisis to a crisis of nations.  Last year we were worried about large banks that we ‘too big to fail’, which resulted in the biggest bailouts in history.

Next year, the crisis is going to be about entire nations failing, sending their currencies sinking as investors quickly remove their investments.  As a nation begins to fail, it destabilizes the neighboring nations and regions of the world, quickly threatening all assets like stocks, bonds and currencies related to the failing nation.

We saw a little bit of this last year when Russia’s currencies plunged with the value of oil and other commodities. 

Resent examples

In the last few weeks, we have seen the dramatic affects on the market with the possibility of the default of Greece and Dubai.  Lucky for Dubai, they have wealthy oil rich neighbors to bail them out and stop an investor run in the area. 

Greece on the other hand has caused much more of a scare because they are part of the EU and if they default on their debts, the Euro could be in big trouble.  Germany the largest exporter of the EU has also reported some disturbing news as exports continue to decline from the global recession.

This is destabilizing the value of many currencies around the world, which is also driving up the value of other currencies even though other nations maybe in worse trouble.

The dollar has greatly benefited from the troubling news.  On the other hand, the Federal Reserve continues to keep the interest rates near zero and Congress continues to spend money they do not have, which has already caused the U.S. Treasury to create trillions of dollars of new money to pay for these expenses.

U.S. Risk of Default Increasing

China, India and Japan also begun to purchase less Treasury Bonds and diversify their wealth funds to gold.  This will cause the U.S. Treasury to create even more new money to purchase their own issuing bonds and further risking the default of the dollar itself. 

As the damand for Treasury Bonds disappears, interest rates will be forced up, which will drastically increase the cost of U.S. interest on its trillions in debt.

The S&P financial rating agenda has again issued a warning that unless the U.S. deficit is cut, they will soon need to downgrade U.S. Treasury bonds.  The only reason they would do that is if there is a risk of the U.S. defaulting on their debts.

To my surprise, that news has not caused a selloff of the dollar, perhaps because the EU news has caused a greater risks of default – at least in the near future vs. the dollars default could still be a few years away.

The U.S. will not default because like every other nation that has control over their printing press; they will choose to inflate the currency before defaulting. 

Greece and Germany do not control the creation of Euro’s and therefore are at the mercy of the market or they will be forces to create their own currency like California did a few months ago – by printing paper money in the form of IOU’s with a promise to be redeemed for dollars in the future. 

Perhaps the EU will create new Euro’s and bailout these nations, but they have been much more resistant to inflating their currency then the U.S. has been because of the lingering history of what happen before WWII. 

In that case, these nations will be forces to make drastic cuts to government spending to improve their books.  In other words, they are going to make the right decision and cut spending in order to preserve the value of their currency.

The U.S. is doing the exact opposite, which will eventually lead to a selloff of the dollars and a rise of the Euro. 

The currency price fluctuations will eventually reverse as the right decisions are begin made in Europe and the wrong decisions are being made in the U.S.

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