Will Sovereign Debt Contagion Cross the Atlantic to the U.S.?


Will their banks be dragged into the crisis?

Even after the massive rescue package ($750 billion) was delivered, confidence in the euro seeped away and it weakened to $1.2320. With U.S. sovereign debt at unacceptable levels too, will the debt 'contagion' cross the Atlantic? More than that, if bond values continue to drop, will the lending banks survive? Can this happen in the States, and will their banks be dragged into the crisis?

President Obama himself gave alarming signals last week, encouraging all parties to come to the rescue. Perhaps he thought his input would add a positive note of confidence to Europe. Why did he get so involved? Was it because of the fear that the U.S. would fall into the same situation?

The package of new loans given to Greece seem to be more than enough to hold off the creditors until Greece has got its budget in order. But can Greece deliver the goods? When their turn comes, can Portugal, Spain, Italy and even the U.K. adjust their budgets to convince future creditors that they can adjust their imbalances in time? Will they be able to repay any of this debt? Will they restore market confidence in their bonds? Countries cannot readjust their focus quickly. It usually involves a decades-long reshaping of a nation. Will the people support their government's commitments? Let's be frank: few believe they will. Remember all that debt to Africa in the last half of last century? It never was repaid and it took the banks 20 years to write it off their balance sheets. But this time we are talking of crises in the developed world. Who's going to bail them out if these loans aren't repaid? Many believe this is the beginning of the end for the euro.

The U.S. has a chronic debt problem of its own and has not addressed it properly yet. Oh yes; it is the biggest economy on earth, so one would expect all others to need it too much. Yes, it is too big to fail; or is it?

No wonder 'swap' lines have been re-opened again. These are lines of dollars given to European banks against the supply of euros in exchange for them. These are given on the understanding that they will be returned in the short-term. Their purpose is to “supply dollar liquidity” to the banks there. They are very useful in intervening in emotional markets to calm them, then when all is quiet the swap back takes place. But what if confidence is so damaged that the crisis moves to medium or long-term? Then as with all lenders they are 'at risk.' Right now they are probably being used to support the euro in foreign exchanges. If speculators gang up together and sell euros against their buying, will more dollars have to be 'swapped?'

If markets get the message that Sovereign debts are not good investments, then U.S. Treasuries could fall foul of that fear. For over a year, China has been expressing fears over the value of treasuries. What if they decide not to keep lending their surpluses back into the U.S. or just slow them? The global monetary system will then change through crisis. These questions are on the brink of being answered and most think that the answers will hurt us all.

That's why the gold market is so strong. But will it stay strong?

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