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The Next Crisis of 2010: How Central Bankers Could Botch This Recovery and Spark the Next Crisis

Eric Roseman (February 2, 2010)

From Montreal, Canada: If you’re looking for the next crisis, then yes, you could look at Greece, Ireland, and Spain. But frankly, they’re just the tip of the iceberg.

Instead, I would examine the world’s central bankers.

Right now, the world’s fate rests in the hands of central bankers. And the odds of all these bankers botching this recovery is growing.

In fact, it’s very possible that bungled polices from central banks will trigger the next financial crisis. If I had to guess, I’d say that crisis will come in either the debt markets or foreign exchange.

Let me explain…

China & Sovereign Debt Are NOT Healthy Yet

The world remains glued to China for any signs that they might be tightening their credit.

But at the same time, China could unleash the next blitz on world markets. Lately, China has been making dangerous attempts to drain excess bank reserves amid the full-blown asset mania since 2009. That in itself could spark the next crisis.

In my opinion, the world has staked too much on China and her ability to navigate her bulging asset bubble. I’m betting there will be some sort of policy error as China strives to cool her economy.

Meanwhile, sovereign state borrowing will increase again in 2010. The United States and Europe alone require at least $5 trillion dollars of funding this year. All that cash has to come from somewhere.

If governments can’t secure the necessary capital, then central bankers will have to mop-up excess paper that the markets can’t absorb. In other words, quantitative easing will come back into play. And the more paper central banks absorb, the higher the risks we will suffer a massive credit overshoot in this recovery cycle.

In 2009, the United States issued almost $2 trillion dollars of debt financing courtesy of Treasury.

The Fed purchased 17% of all Treasury issuance last year (aka “quantitative easing”), according to Montreal-based Bank Credit Analyst. In 2010, U.S. borrowing is likely to exceed $2 trillion dollars.

Europe Has Their Own Problem Children

In Europe, a full-blown credit squeeze is already attacking Greek financing costs. As I’m sure you’ve read, the threat of a default continues to rise.

So far, Greece is still raising money without external assistance. But if the EU decides to bail them out, that will take funding. Again, that’s a negative for the EU.

In 2010, Europe is projected to raise €2.2 trillion or $3.1 trillion dollars to fund ongoing financing requirements by the United Kingdom and the continent.

According to Fitch Ratings, the projected borrowing represents an increase of 3.7% from the €2.1 trillion raised in 2009. As a percentage of gross domestic product or GDP, borrowing is expected to be the largest in Italy, Belgium, France and Ireland.

The $5 Trillion Question

The question is how much sovereign debt will global markets absorb in 2010 without unleashing some sort of debt financing crisis?

Worse, if the global economy suffers a double-dip recession in 2011 or 2012 then we will have all the ingredients for a full-scale sovereign debt crisis. In fact, it’s almost a guarantee because by then governments will have already exhausted the markets’ goodwill.

Central banks will rescue any leftover scraps of failed auctions. But it’s still possible that all this central bank meddling will just cause a significant credit overshoot. In other words, they will pour too much liquidity into the markets, and then we will see the worst inflation since the 1970s.

Perhaps you already know the rating agencies are conduits for central banks. But still, they might be compelled to downgrade some sovereign debt. That would force pension funds to unload what was formerly known as “super-safe paper.”

Greece, Spain, Ireland, Portugal and the United Kingdom come to mind as likely downgrade targets. The United States also deserves a credit downgrade but it probably won’t happen. (The U.S. has the power to terminate the credit agencies overnight if they really wanted to.)

In my book, the entire financial system is rigged.

In Short, They Could Get It Wrong…Again

The risks are increasing that the Fed and perhaps other central banks will get it wrong this year. The worst possible mistake is to hike lending rates.

If the Fed starts tightening credit then we can kiss commercial real estate financing goodbye. Financing is still highly impaired going into 2010.

But then again the Fed has never “got it right” since its sad birth in 1913 and probably won’t do the right thing in 2010.

There is a monster price tag yet to be paid for all of this borrowing to bailout the banks and other industries since 2008.

It’s naïve to assume we’ve seen the worst because too much government paper will eventually flood demand and cause a serious spike in interest rates at exactly the wrong time.

Bottom line: The Fed and other central banks around the world are NOT all-powerful. We already know they can make mistakes. Get set for their next one coming in 2010.

All the Best,
Eric Roseman, Investment Director
The Sovereign Society

EDITOR’S NOTE: Each writer you hear from this week will also be making an appearance at our big event, the Total Wealth Symposium in Montreal this May. This is our huge Super Bowl investment event of the year – where we invite over a dozen speakers from around the globe to speak on everything from AAA bonds to the savviest retirement plans. Get the details here.

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