Sovereign Debt Exposure

Banks hold government securities as part of their portfolio.  Historically, these investments were viewed as zero risk instruments, similar to cash.  That has changed.  Sovereign debt now has a risk factor associated with it.  Greece is now the poster child for risk.  European leaders have figured out that a bank’s capital could get wiped out with a default by Greece.  Generally a bank’s capital structure accounts for no more than 10% of its deposits.  This is 2008 all over again.

The U.S. is in a serious recession.  Banks have kept families in houses without paying their mortgage payment so they could at least take care of the property and keep the loss off the books for now.  China is entering a recession and will create a serious financial tsunami around the world.  Manufacturers are unable to get bank loans because credit has dried up and are now being subjected to the loan sharks.  Companies are shutting their doors and causing a drop in the Gross Domestic Product (GDP).  Inflation is understated thus China’s GDP looks better than it actually is.

The interconnectedness of countries has created a domino effect as mentioned in a previous blog.  Rather than financial instruments staying inside the borders, they are sold to investors around the world.  Wall Street has enticed investors with higher returns but without the understanding of the fragility of the issuing country.  The counterparty risks of all of these financial instruments are now being exposed and the holders will soon have a “come to Jesus” meeting.

The U.S Dollar is currently the safe haven of funds from around the world.  It is the least ugly of the ugly sisters.  Where will value be stored if the U.S. Dollar tanks?  I believe it to be Gold & Silver.

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