Patersons strategic paper:
""The debt trap
We note that few countries have addressed debt accumulation which continues to amass at rates proportionally above economic
growth. Defi cit spending by governments has in theory helped economies such as the US remain outside recession levels. However
it is important to note that particularly for Japan, the EU, and to a lesser extent the US, potential exists for countries to ultimately
become caught in a “debt trap” whereby debt accumulation cannot be reduced without throwing an economy into recession, and
once a recession starts tax take reduces, reducing the ability of a country to service debt. We would suggest Japan, the third largest
economy in the world, is either already caught in this position, or will become caught in such a position in future. Japan’s Debt to
Gross Domestic Product (GDP) will cross the 235% mark late in 2012, equivalent to US$100,000 per Japanese citizen. The Japanese
10 year Bond yield only needs to move a few percent higher and the country would be unable to service its debt via tax take.
Central bank Quantitative easing (QE) efforts have been designed to both add liquidity to economies in an attempt to stimulate
economic growth, and to act as demand replacement for the government Bond market. Essentially, in its most basic form QE is
money created and used to purchase a country’s own Bonds. Bond prices move inversely to Bond yields, so if a government bids up
its own Bond prices at the same time it forces down Bond yields.
Government debt is estimated at approximately US$48 trillion against an estimated global GDP of US$69 trillion (IMF est.). Because
debt must be rolled forward if not paid off this creates a signifi cant ongoing demand for Bond market funds. Debt serviceability is
being enabled in many countries by current very low Bond yields, maintained by a combination of QE and ironically fear, which sees
funds fl ow to Bonds that appear safer to hold. For instance 10 year Bond yields in the US (1.59%), Japan (0.81%), Australia (3.09%) and
Germany (1.48%) are being held down in the case of Japan and the US by a QE, fear combination, and in Germany by the fear factor
as a large outfl ow of funds move from Greek, Spanish and Italian banks to perceived safety in German Bonds.
While in SE Asia/China/Australia portfolios are still positioned for profi t making, considerable fund fl ow around the world today is
simply focused on asset or value preservation. A primary concern of thinking market investors is that central bank liquidity efforts
could simply create another economic bubble that will ultimately deflate.
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