Dubai May Be Least Of World's Debt Problems
The Persian Gulf emirate Dubai is seeking to defer debt payment on nearly $90 billion in liabilities from its state-run companies. Like many other over-leveraged enterprises and some countries across the globe, the government of Dubai made massive bets on real estate that have since gone sour. But no matter where in the world such cases occur, the ramifications of taking on too much debt are the same. Unless the party in question can be bailed out, the deleveraging process usually leads to default and insolvency. It makes no difference whether it's a business, like AIG (NYSE:AIG), or Bank of America's (NYSE:BAC) Countrywide Financial, or a country,
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the entity in question must always be able to service its debt, either by generating revenue or taxation. If the enterprise or state becomes too extended, it becomes perilously dependent on perpetual economic growth or on perpetually low interest rates.
It's not just Latvia, Ukraine and Dubai that are cause for concern. Even economic giants like Japan and the United States need to take heed. The examples produced over the last few weeks and months should send a stark warning to the U.S. that we cannot continue to operate at our current levels of monetary and fiscal profligacy and expect the outcome of our Treasury auctions to remain positive forever. It is considered common wisdom that the appetite for sovereign U.S. debt, and for our currency, is inexhaustible. Common wisdom also had it not long ago that real estate values never fall across an entire nation. The fact is that we've never been more overleveraged as a country. Our record national debt (defined as the total public debt plus intra-governmental debt held by trust funds like Social Security) now stands at over $12 trillion. Total non-financial debt (debt of households, businesses, state and local governments and federal government debt) as of the second quarter was a record $34 trillion. Household debt as a percentage of GDP now stands at 96.5%. That same debt expressed as a percentage of disposable income is at 129% - both just under their high water marks. Perhaps most surprising, given our record low and artificially induced interest rates, is that our Financial Obligation Ratio (debt service payments as a percentage of disposable income) is, at 16.6%, less than one percentage point off its all-time high. The icing on the cake: Our projected debt over the next 75 years is over $106 trillion. (For background reading on this problem, see Breaking Down The U.S. Budget Deficit.)

Our annual budget deficit of $1.4 trillion in 2009 shattered all previous records and the projections are that another trillion dollars in government debt will be added annually over the next decade. The amount of debt that needs to be rolled over each year is increasing because of the government's decision to finance our debt at the short end of the yield curve. The result is that the U.S. Treasury must sell trillions of dollars in debt into the market each year - and not merely find lenders to finance the difference between what our government takes in and what it spends during a given year.

So far, there is little evidence of distress in the bond market. Last week the Treasury sold $44 billion in two-year notes at a record low yield of 0.802%. Although the yield on the 10-year note has averaged 7.31% over the past 40 years, it currently stands at just 3.22%. The all-important indirect buying (which includes that of foreign central banks) of U.S. debt jumped to 45% of the total in 2009 from just 29% last year.

The U.S dollar remains mired in a vicious bear market that has gone into overdrive this decade. The deadly combination of skyrocketing debt sales and a chronically weak currency may soon pull the rug out from our Treasury auctions. It is completely irrational to count on record-low interest rates persisting while debt issuance continues to break records. Interest rates must rise dramatically to reflect the record level of supply and the inflation potential inherent in a $2 trillion monetary base. The added payments resulting from those rising interest rates will send deficits soaring. Sooner rather than later the foreign appetite for U.S. debt will wane, simply because foreign investors will discover they have concentrated positions in assets (U.S. Treasuries) that are falling in value and denominated in a currency that is being debased.
The way to head off this nightmare scenario is for the U.S. to defend the value of the dollar now and stop the endless cycle of bailouts, inflationary policies and dependence on debt before the only person who shows up at our Treasury auctions is Banana Ben Bernanke with his printing press in tow.

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