There is no need to throw out another rambling dialogue over indebtedness and the sovereign risk that is or is not priced into markets.  Regardless, this chart shows an interesting “Venn Diagram” of the groupings of nations as measured by their deficit (as a percent of GDP) plotted against their federal indebtedness.  We have discussed in recent posts Japan, and the nearly 200% of GDP tsunamai of debt they have hanging over their heads.  But PIMCO intelligently groups Japan and some Western nations into a Ring of Fire. 

These include: US, UK, Spain, France, Italy, Ireland, Greece and Japan: 

PIMCO: Ring of Fire

 The general justification for the fiscal deficits central banks have run were that it was necessary at the time, and that the private sector would eventually replace the government’s money. PIMCO put it this way: 

“the global private sector is now expected by some to detox and resume a normal cyclical schedule where animal spirits and the willingness to take risk move front and center.” 

That has yet to take shape.  We have long felt that what what will turn this recovery into a “sustainable” economic recovery will be if this return of animal spirits ensues.  PIMCO says the following: 

“But there is a problem. While corporations may be heading in that direction due to steep yield curves and government check writing that have partially repaired their balance sheets, their consumer customers remain fully levered and undercapitalized with little hope of escaping rehab as long as unemployment and underemployment remain at 10-20% levels worldwide.” 

PIMCO then goes on to discuss Reinhart / Rogoff who put together a seminal study called “This Time is Different: A Panoramic View of Eight Centuries of Financial Crises”. Link is included below.  We saw Carmen Reinhart speak at the Inter American Development Bank presentation in Miami a few years ago. She is a stunning academic, with forceful thoughts and words to be heeded. Her study almost implied that over the long run, no governments pay off their debt! Very interesting read, and though long I strongly suggest you read it. 

The important point to remember about the historical analysis of financial crises is that “the starting point is important”.  The following table shows the gross level of public and private debt (measured as a percent of GDP).  The results are impressive - and scary considering the precarious situation of the US, UK and Japan. 

Total Debt as a % of GDP

The next chart shows the total indebtedness (as a group) of advanced (red) versus developing (blue) countries. One can see why the emerging markets escaped from the financial crisis relatively unscathed.  Their financial markets performance was another story. 

Developed versus Developing

Bill Gross and PIMCO continue to put out their monthly Investment Outlook for free. It is available to the worldwide financial community, giving you rare, FREE, access to one of the preeminent thinkers on investment strategy.

Gold and the 200 day moving average

We would bet though that this is not the time to expect a selloff on par with these previous technical related selloffs. In addition note that the last major selloff in Gold was from early 2008 to end of 2008 which of course coincided with the financial crisis, the stronger US$ and therefore weaker commodity prices across the board.  A quote from Marc Faber provides an interesting take on Gold for the next 6-12 months:

“A company’s stock could be less expensive at 100 dollars than when it was selling for 10 dollars, because earnings growth has outpaced the appreciation of the shares and therefore its price/earnings ratio has declined. So gold could be cheaper at the current price than when it was at less than 300 USD because of the explosion of foreign exchange reserves in the world, zero interest rates, the huge debt overhang, and the expectation of further money printing.”

Don’t get us wrong. Gold was one of the best performing global assets in the 2000s decade, and its unlikely it will carry forward with that leading performance. But for right now we see Gold trading much higher.

The Covert Analytics Team

Here are the links:

Barry Ritholtz’s link to David’s Commentary at the Big Picture

About Barry: Barry is awesome. I cant wait to meet him one day. He was the first blog I ever cared to read, and the only one I still religiously read.  He makes economic data fun, and he is extremely insightful.

BCA Research

About BCA: Great research. Their GIS (Global Investment Strategy) is something I strongly recommend to any one invested in the global markets. It is written by Chen Zao – a great personality and a great gift at explaining trends in simple concepts.

David Kotok’s Company

About Cumberland: Fixed income money managers, but if its run by David, I would not question it.

Click here for Bill Gross article

With the Fed Funds Rate at practically zero, and the 10 year around 3.5%, the bullish case for interest rates is weak. The bearish case of skyrocketing inflation and a Fed hiking rates seems years away at best.  CPI bottomed at about -2.0% in the middle of this year and the recent reading is about 1.8%.  Still mild by long term measures, but a situation that is worth monitoring. It is also notable that the deflationary numbers in the middle of this year were due to drastically lower energy prices compared with the middle of last year (when Crude peaked at nearly $150 per barrel).