National Bankruptcy? Not Quite Yet

Bill Gross tumbled the Treasury markets yesterday by warning that the US might lose its AAA rating. That means today is a good day to buy Treasuries. Bill Gross has been a contrarian indicator since Jan. 28, when he advocated buying risky securities, including preferred. I’ve been watching the cost of credit protection for the US and the UK since the beginning of the year, noting in April how close we came to national bankruptcy. I wrote at the time, “Bill Gross is wrong again,” and the same applies today.

What I have argued since Jan. 23 is that the G7 sovereigns and the banks are joined together at the hip, thanks to the multi-trillion-dollar commitments that governments have made to the banks. S&P with its typical backward-looking sloth only got around to inspecting Britain’s barn door after the horses had been gone for months.

For the tenth time: The gauge to monitor is the cost of credit protection on the G7 sovereigns which Markit Partners reviews daily on a free site:

Ticker	CLIP	Name	5Y Today	Daily Chg (bp)	Weekly Chg (bp)	28 Day Chg (bp)
USGB	9A3AAA	Utd Sts Amer	29	-1	1	-19
JAPAN	4B818G	Japan	50	0	0	-19
DBR	3AB549	Fed Rep Germany	30	-2	2	-13
UKIN	9A17DE	Utd Kdom Gt Britn & Nthn Irlnd	72	-1	5	-27
FRTR	3I68EE	French Rep	36	1	2	-10
ITALY	4AB951	Rep Italy	84	-3	3	-32

The UK had been up at LIBOR +164, trading at banana-republic levels, and is now back down to manageable levels.

As the long deterioration of the economy continues, more cracks may appear in the facade of G7 credit, and it seems wise to start layering in hedges in a small way. But by and large, the sovereigns are doing very little because the banks are doing very little. The other failsafe indicator to watch is the risk of bank equities, i.e., the cost of options on bank stocks. Here’s Bank of America (BAC), one of the tippier ships in the fleet (click to enlarge):

Implied Volatility on BAC Options Falls Faster Than Historical Volatility

BAC hedging costs are a third of their March peak.

It’s a time to pick hedges carefully (commodities, for example), not to run for the exits. Low vol means that no one is running.

I note, by the way, that the UK banks regained the ground they lost yesterday, and that US banks are up in pre-market trading.

Comments

[Hot Richard:]

Maybe not when this article was written (yesterday), but TODAY...yes.

May 22 10:48 AM

[Jeff Nielson:]

The question is not "is U.S. bankruptcy possible"? The REAL question is: "is there ANY way to prevent it"?

The numbers speak for themselves: $50 TRILLION in total public and private debt + ANOTHER $50 TRILLION in unfunded liabilities for the U.S. government.

The U.S. cannot even SERVICE this mountain of debt, let alone generate some absurd "economic recovery".

Wake up people!!

May 22 10:56 AM

[K T Cat:]

A quick synopsis of the no-worry crowd's argument suggesting that the Dollar is just fine: "Hey, we're not bankrupt yet!"

May 22 11:45 AM

[Kinabalu:]

"Bill Gross has been a contrarian indicator since Jan. 28, when he advocated buying risky securities, including preferred."

Sorry David, but my bank Preferred Stock ETF is up 41% since I bought it on January 23.

May 22 11:54 AM

[carey_jim:]

And it might be true that recent short term market fluctuations are random noise and the thoughts of Bill Gross are useful financial information.

Just because the financial world is crazy doesn't make reason useless.

May 22 01:18 PM

[Mad Hedge F...:]

Not yet. ) I can’t think of a better reason to keep a core long term position in gold than the prospect of the US losing its triple “A” rating. The chatter about this yesterday took the barbaric relic up to a two month high of $958, a mere $50 from an all time high. Quite honestly, I never understood why the American rating has stayed this high for this long. If any other entity had increased their debt from $5 trillion to $11 trillion over the last eight years, then boosted it to $13 trillion over the last three months, their rating would have been slashed ages ago. Like to the level of Zimbabwe. Is it any surprise that gold demand soared by 38% in Q1, according to the World Gold Council? And now the Russian Central Bank is allowing other banks there to pledge gold as collateral. Keep your gold position so you don’t miss the inevitable gaps up, as well as miners, like Barrick Gold (ABX).

May 22 01:52 PM

[Living4Divi...:]

Yes we boosted our debt to $13 T. But, we are the largest economy in the world. Our debt/GDP ratio, while high is still by far not the highest. This gives me much concern but I disagree with you: we won't be like Zimbabwe.


On May 22 01:52 PM Mad Hedge Fund Trader wrote:

> Not yet. ) I can’t think of a better reason to keep a core long term
> position in gold than the prospect of the US losing its triple “A”
> rating. The chatter about this yesterday took the barbaric relic
> up to a two month high of $958, a mere $50 from an all time high.
> Quite honestly, I never understood why the American rating has stayed
> this high for this long. If any other entity had increased their
> debt from $5 trillion to $11 trillion over the last eight years,
> then boosted it to $13 trillion over the last three months, their
> rating would have been slashed ages ago. Like to the level of Zimbabwe.
> Is it any surprise that gold demand soared by 38% in Q1, according
> to the World Gold Council? And now the Russian Central Bank is allowing
> other banks there to pledge gold as collateral. Keep your gold position
> so you don’t miss the inevitable gaps up, as well as miners, like
> Barrick Gold (seekingalpha.com/symbo...).

May 22 02:57 PM

[popey:]

Bill is not perfect, but on his latest call I agree. The sovereigns are also connected by currencies and the US dollar is about to die. Ergo US sovereign debt, long dated, is dead paper. I completely disagree with your position and will continue to short long dated paper at every opportunity.

May 22 06:23 PM

[User 357705:]

Not quite yet, perhaps. Inevitable, of course.

May 23 03:45 AM

[a. palmer jr.:]

I think we need higher interest rates. We need a safe alternative to risky stocks and still riskier corporate bonds. It would probably save the US in the long run because of all the retirees needing income rather than ask the US for bailouts when their pensions run out of money.

May 23 08:18 AM

[The Aft Deck:]

As various currencies come under pressure, most notably the USD then Commodities will become the safe haven.

No one could expect the dollar to survive the onslaught of debt the US Govt have delivered. Where is the long term plan to rebuild the economy to add the value back to the USD.

The Author correctly points out that many other leaders around the world are following the Obama policy of debt, so do not expect such a huge fall in the USD against all currencies, but against Gold, Oil and other traded commodities expect it to keep diving long term.

May 23 12:43 PM

[Jeff Nielson:]

The Aft Deck, I'm going to have to disagree with your remark "other leaders around the world are following the Obama policy of debt, so do not expect such a huge fall in the USD against all currencies..."

Yes, ALL governments are spending recklessly NOW. However the fiscal condition of the U.S. economy BEFORE this started was so much worse than EVERY other major economy that this is why the dollar will not drastically lose its purchasing-power, but it will fall MUCH further than almost all other currencies.


On May 23 12:43 PM The Aft Deck wrote:

> As various currencies come under pressure, most notably the USD then
> Commodities will become the safe haven.
>
> No one could expect the dollar to survive the onslaught of debt the
> US Govt have delivered. Where is the long term plan to rebuild the
> economy to add the value back to the USD.
>
> The Author correctly points out that many other leaders around the
> world are following the Obama policy of debt, so do not expect such
> a huge fall in the USD against all currencies, but against Gold,
> Oil and other traded commodities expect it to keep diving long term.

May 23 02:20 PM

[Wise Owl:]

China's currency would be the safest bet, due to their balance of payment and future increase in internal consumption.

Yuan/dollar ratio would increase, there is high probability.

May 23 02:57 PM

[reveigel@ms...:]

If the dollar is not worth anything, has the government gone bankrupt or has it caused, by it's actions, bankrupted it's people? At that point does it really make any difference?

May 23 05:22 PM

[Mr. Ed, Jr.:]

Well, I'll be darned. It seems like only a few weeks ago, the "green shoots" crowd was telling us that the USD was the "world's safe haven".

Oh.....I misunderstood......they said it was the "world's Cliff Clavin".

I guess I have some trades to unwind Monday morning.

May 24 03:05 AM

[LKofScotland:]

What's the problem with Cliff Clavin'? Even postal workers have to eat you know. Love the talk of high finance. Everyone buying their bread in euros? Sure you are. How about protection? All those Army and Marine corp divisions being paid in gold? Yeah, right. Keep bangin' on those bongos like chimpanzees you flag burnin' heathens. In the meantime hoard your property, get your squeeze to rub your bunions and take a gander at the ammo supply at Wal-Mart as a measure of your well being.

May 24 10:42 AM

[chleoku:]

Of course US won't be bankrupt but the depreciate of the dollar would be bad enough. It's also useful to note that the recent swine flu outbreak in US may add further complication on the already weak economy.

Compared to US, China economy is already in bull cycle, which would push RMB to stronger than ever:

www.wealthalchemist.co.../

May 24 10:50 AM

[Missing_Link:]

And now, President Barack Obama admitting that the US is already bankrupt:

www.drudgereport.com/f...

On May 22 08:58 AM Ferdinand E. Banks wrote:

> Mr Woong said what I was going to say: Essentially, the very idea
> of the US going bankrupt is preposterous.

May 25 09:05 AM

[Charles Pet...:]

Great article. I love how everyone is claiming that this is the fall of Rome. If the United States is going to go from AAA to AA, what is going to happen to the rest of the world and why would any single company stay AAA? The U.S. Dollar is backed by guns, missiles, battleships, nukes, etc. not by some commodity like gold that is worthless in terms of functionality. The Dollar is worth what the government says it is through fiscal and monetary policy and not anything else.

May 25 10:57 AM

[Jimmijimmi123:]

bankruptcy is bound to happen even to the tycoons... It just depends on how we deal with it that determines thier outcome: whether they sink or swim so to speak

May 25 11:26 AM