Sovereign Debt Issues to Tank Stock Market

A sovereign debt panic appears to be just over the horizon and is likely to tank stock markets around the world. While the current crises is centered on Greece and the Euro zone nations, especially the PIGS (Portugal, Ireland, Italy, Greece, Spain) the issue of excessive debt extends to first tier nations such as the United Kingdom and the United States.

Very likely, in the coming week or two a major leg down in the stock market will commence as the fear of financial contagion from the ongoing Greek tragedy of mismanagement, deceit, corruption, and incompetence, spreads from the euro zone to disrupt stock markets worldwide.

“Questions continue to mount about the near-term fate of Greece and the other PIGS nations,” wrote Kevin Giddis, head of fixed-income sales, trading and research at brokerage firm Morgan Keegan Inc. in Memphis, Tennessee, in a note to clients yesterday. “The latest worries are the lack of specificity about the true nature of the ‘determined and coordinated action’ pledged.”

Then there is Dubai, probably the greatest financial boondoggle that the world has ever experienced, except for perhaps China which is yet another bubble that will eventually pop as over building and wild speculation continues until it doesn’t. But China is a story worth writing about in a separate article so I’ll pass on it today. When the China bubble does pop it will be a hundred times, maybe a thousand times, the size of little Dubai so remain alert.

It would appear that an implosion of Dubai has only been delayed, not avoided. This past Friday the cost to protect against a default by Dubai increased to the highest level since state-controlled holding company Dubai World said last year it wanted to delay debt repayments. Credit- default swaps linked to Dubai debt jumped yesterday to 638 basis points, the highest since Nov. 27, according to CMA Datavision.

The sovereign debt issue is actually quite deflationary in nature. As nations such as Greece struggle to reduce their public debt to GDP ratio, they will be forced to drastically cut expenses and to reduce government services. These actions, while necessary, will reduce economic activity at a time when the world economy has still not fully recovered from recession. A feedback loop will inadvertently be created that will lead to further reductions in economic activity, thereby increasing deflationary forces.

Of course, Greece, euro zone countries, and Dubai, are small potatoes compared to the increasing excessive debt issues being experienced by the United Kingdom and the United States. The public debt levels of the UK and US are increasing exponentially and cannot be sustained. The greatest financial boom that the world has ever experienced began to unravel with the toxic waste home mortgage debacle beginning in 2006. We seem to be only in the early stages of the bust cycle.

Almost unbelievably, public sector debt levels have continued to increase as nations worldwide have continued to pile on additional debt in an effort to reverse deflationary forces. While it only stands to reason that the cure for an excessive debt problem cannot be realized by the addition of debt that hasn’t stopped the politicians of the world from creating additional debt as if it would never matter.

Great booms always end in great busts. Since we have recently experienced the greatest boom in the history of finance it is highly likely that we are entering a time when we must cope with the greatest bust. Sovereign debt issues may well be the triggering event that tanks the stock market and ushers in a long crisis of deflationary forces.

We will probably not have to wait very long to find out.