Written by Nathan White, Chief Investment Officer, Paragon Wealth Management
One of the reasons I have been so negative on government debt is that the reward, the interest rate offered, wasn’t enough to compensate for the risk at these low levels. One of the problems with debt is that when rates are low too much tends to get borrowed. After all, the financing costs are so cheap when rates are low that it seems like you can afford all sorts of things. However, the fairy tale comes to an ignominious end the moment rates begin to rise and then the true ramifications and cost of holding significant debt become apparent. The southern European countries were getting a free ride in the European union by obtaining lower borrowing rates than they otherwise would have been able to obtain. Because they were able to get artificially low rates they borrowed to the hilt to finance the ever expanding entitlements states. These socialistic policies encourage even lower levels of productivity because no one is incentivized to work. The only way to sustain the charade is by borrowing even more. Socialism is expensive.
With Italian 10 year rates now around 7% I believe you are finally seeing where their rates should truly be to reflect the risk of holding Italian debt. With high levels of debt to GDP and a bloated inefficient public sector the higher current rate shows the true cost of how expensive their government has become and how it doesn’t take much to make it unsustainable.
With Europe still going through what some call the messy “sausage making process” of actually putting policies in place to deal with the debt crisis the markets will continue their volatile ways.
Let’s just hope that once the European debt crisis comes to whatever end that the same reckoning won’t then be focused on our debt situation here….Are you listening Super Committee???
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