Penal Colony Debt = The Best Around?

The most epic shell game in the history of man kind, otherwise known as the next financial crisis, is coming.  At the end of which everyone will flip over their cups and discover that they’re empty… Well not everyone. That good ole’ penal colony south of the equator may be one of the safest places to hold money.

We have acquired the most amount of debt during peace time in history but don’t tell that to central bankers. They’ve been fighting the greatest war in the 21st century, World War: Deflation. Five years in and the central bankers are returning home from the front like they have dealt the final blow to the monster once and for all. Of course, the Bank of Japan who has been fighting the monster for decades, knows the war is not yet won and continues to fight the beast to the bitter end. Unfortunately the bitter end would be a significant improvement on the more likely outcomes of war and hyperinflation.

Unlike what most sociopaths will tell you, war has costs. The cost of the Central Banker’s war is confidence in fiat currencies. Via money printing, central bankers have kept interests rates artificially low which has allowed government debts to sky rocket to record highs. Since the debt is so much higher than revenues, governments can only pay off the debt at a low interest.  The bursting of the global private debt bubble will cause a sharp contraction in GDP which in turn lowers government revenues. With lower revenues the governments will be faced with two choices either lower interest rates to ludicrous lows or default. Only a few countries will have the first option. Most will be forced to do the latter.

This brings me to Australia.

For the following reasons I like Australia’s public debt above all other.

  • The government cuts spending.
  • Commodities Export Country.
  • Low public debt to GDP (20%).
  • High House Hold Debt to GDP (140%).

The Australian government is cutting spending. This is good for two reasons.
1) It reduces the supply of government debt.
2) It slows down the economy which slows inflation.

Secondly, Australia is a heavy export country whose biggest trade partner is China. This can be seen as a good thing and a bad thing. If we just look at the fact that Australia is a heavy export country we see that in the next debt crisis, commodity prices will plummet as global trade slows. This will cause Australia’s economy to contract and possibly crash leading to an rotation of private debt to public debt. Unfortunately Australia and commodities prices are sort of tied to China at the moment. Early in the year China tried to let some businesses and loans fail but quickly realized how bad things would go if they allowed defaults to continue. So now the Chinese are doing more QE, which could push up commodity prices and push up inflation short term in Australia. It is a concern, but losing a few percentage points to inflation and rising yields short term pales in comparison to flipping ones cup over only to find nothing. In short, if you buy Australian bonds now, you may eat some inflation due to China’s last ditch effort to forestall an economic collapse.

Moving on to public sector debt we find that when compared to revenues it comes in at a paltry 54%. Japan and the US on the other hand have public sector debt to GDP ratios of 750% and 400% respectively. For most EU member nations the number is around 100% but those numbers are skewed due to size of government relative to their economies. The point being, in a debt crisis, Australia will be able to absorb more debt without defaulting. Therefore we can think of Australian government debt as safe and of this safe debt, Australia happens to have very little, sitting at 20% of GDP. This number shrinks when comparing it to Australian household debt which sits at a whopping 140% of GDP.

During the next financial crisis, there will be a flight to safety. From the risky private sector to the “safe” public sector. This initial panic will greatly benefit Australian public debt, since there is so little of it to begin with. Once governments around the world start defaulting on their debt, there will be a greater panic as people seek to put their money in the safest place possible, Australian public debt… and gold.

In reality, buying Australian public debt is a kin to buying gold. Both are safe assets which will see enormous inflows when the panic starts. I think gold is safer in some regards and may see more appreciation but Australian public debt is more liquid and pays interest. In the end it’s a trade off and another way to diversify.

In case you are looking for something with a little more risk but with a lot more reward I suggest looking at Russia, Brazil and India. All three countries are major export countries with relatively low debt to GDP and high inflation rates. Russia in particular could be a great buy because sanctions and high commodity prices are pushing rates higher. Long term it is unlikely that both persist. That’s it for now.

Winter is coming sooner than you think.