The magnitude of current private and government debt, coupled with massive unfunded contingent liabilities for promises of future services to their citizens, will prove to be impossible for many nations to fund. Massive inflation in the money supply will become the preferred vehicle to deflect the default monster and will result in vastly devalued currencies and price inflation as a prelude to default. Such action will be a desperate attempt to buy time to stave off the inevitable and will result in social unrest caused by persons whose comfortable lifestyle and elevated standard of living is about to disintegrate before their very eyes.

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‘Sovereign Debt’ was once only a phrase found in the arcane prose of economists writing in academic journals. Internet blogs started carrying commentary on the subject after the near-death experience of many large banks but only in the last few months has the mainstream media tuned into the issue of sovereign debt. Quite simply, they could not ignore the omnipresent financial clouds any longer.

What is ‘Sovereign’ Debt?

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In its simplest form, ‘sovereign’ debt means ‘government’ debt, the financial debt of a country. It usually also means the accumulated debts of government sub-entities such as states, provinces, municipalities, agencies, boards and commissions for which the senior government is ultimately responsible.

While existing government debt is the problem for today, contingent liabilities for promises of future services to its citizens dramatically complicates the current debt problem. Unfunded future liabilities are obligations which represent the one ton gorilla peering through the front window of many nations.

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What does Debt ‘Default’ Mean?

‘Default’ is a word similar to the word ‘bankrupt’ when referring to the inability of a private individual, business or institution to meet its financial obligations. When debt is unable to be repaid, a formal declaration of this fact triggers a bankruptcy in a court of law. In the case of government, the inability to pay its accumulated debt from past spending, because it can’t raise adequate taxes or borrow additional funds, means that the government has become insolvent forcing a formal default on its debt.

Which Countries are Most Likely to Default?

According to the Maastricht Treaty which sets the terms of compliance for the sixteen member nations of the Euro currency club, annual deficits are limited to 3% of GDP. Of the 27 European Union member states, according to the IMF and the Global Financial Stability Report of April 2010, only 5 countries (Luxembourg, Finland, Denmark, Sweden and Bulgaria) are below that ceiling. Even worse, of the 22 that do not comply, 14 have a ratio that is more than twice the established and agreed upon limit. Indeed, the EU-27 as a whole, posts a huge 6.9% budget deficit-to-GDP ratio which is expected to increase in 2010 to 7.5% matching Japan’s at 7.5% but paling in comparison with the U.S.’s deficit-to-GDP of 9.2%! For the record, Canada’s stands at 3.0% and Sweden’s is only 0.8%!

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June 3, 2010