The Bank for International Settlements – Sovereign Debt

We wrote about some developments and communications by the Bank for International Settlements (BIS) back on December 12, 2022.  More reading and correlation with other new developments warrants revisiting their concerns.  As we mentioned then, the BIS was certainly not on our list of daily concerns or even in the radar.  But in their latest quarterly report they raised concerns, even waved red flags over the imbalance between settlement partners for large foreign exchange transactions (FOREX). 

In our opinion they raised concerns on two levels.  First, they believed that the lack of transparency between trading partners such that one could be insolvent, and the markets would not know until there was a default.  Second, they raised an appropriate concern over the rapid rise of total FOREX transactions and a shift from settlement to delayed settlement on short term agreements.

Why do any of us care?  Obligations between nations now present a greater risk since markets have become global.  Failures in one country have a way of spilling over to trading partners since they can interrupt the flow of raw materials, interim products, and finished goods.  This can not only interrupt financial transactions but also the availability of food, energy, and technology.  We have seen the effects of the global supply chain interruptions during Covid, but a financial disruption would create a similar crisis

One “Ah-ha” moment for us was when we realized that during the pandemic the U. S. had probably supplied untold quantities of medical, food, and other relief to developing nations.  When these do not take the form of outright foreign aid, they probably involve some type of FOREX agreement.  But by who and to who is the unanswered question?

Then we found an article originally published on January 20, 2022, by RUSBANKROT, an organization that specializes in tracking, understanding, and writing about bankruptcies.  Their article, titled 74 Countries Are at Risk of Bankruptcy Due to the Pandemic.  In the article they point out that the world’s poorest countries are at risk of defaulting on foreign debt because of their inability to meet interest payments.  Adding to their woes are payments suspended in 2020 and 2021 because of the pandemic.  In some fashion the World Bank and the International Monetary Fund are tied up in the mess.

The total debt from these nations is just a fraction of the whole FOREX mess and might amount to no more than $1 trillion of $65 trillion that the BIS warned us of in their report.  But financial contagions have a way of being linked, where one nation might learn that their neighbor got away with bankruptcy, so why not us?

Then mid-year 2022 Reuters warned that there were twelve countries in that same danger (The Big Default?  The dozen countries in the danger zone.)  They cite a rapid rise in bond spreads as investors recognize these dangers.  On the list are countries we always know are financially weak and fiscally irresponsible.  Argentina, Ukraine, Tunisia, Ghana, Egypt, Kenya, Ethiopia, El Salvador, Pakistan, Belarus, Ecuador, and Nigeria all made their watch list.  Then we have Russia who can default on foreign debt easily by blaming sanctions by the west.

And finally, from the Canadian Free Press comes an article titled Sovereign Debt Default & the Black Swan.  The authors of the article point out that sovereign debt is now where it was before the financial crisis back in the 2008 timeframe.  There is no way of knowing whether there will be a Black Swan event because it is an event that is neither forecasted nor foreseen.  To us it is the ultimate “cop out” by economist when they fail to read all the warning signs for significant changes to world economic events.  It certainly gives cover to many of the politicians who create the sovereign debt issues through poor policy.

If we want to bring some clarity to the BIS concerns, we also need to bring into the mix the addition of CRYPTO and the ability to indirectly trade CRYPTO over FOREX exchanges.  The working procedures seem murky, but it appears that a broker/dealer can take CRYPTO in deposit for a customer, create a dollar denominated transaction that is then traded over the FOREX exchange and converted back on the other side of the transaction as a currency, and then into CRYPTO, or never converted.  There is always the risk of the trader taking on the risk and making a one-sided transaction betting on the volatility of CRYPTO over the settlement period with no conversion back.  This would create a trade where the trader was betting on the volatility of both the currency and CRYPTO.  With the anonymity of both Bitcoin and complexity of FOREX, for most of us, this might be the “perfect storm” of transactions.  In relation to all CRYPTO traded this might be a small number, but a risk, nonetheless.  What could possibly go wrong?

Lost in the big picture, and apparently lost on our own pundits on popular daily financial shows, is the divergence in household wealth and daily cashflow.  While the average household income, wealth, and debt may look pretty good, for most Americans prices are up for just about every consumable item.  And even though they like to point to the positive savings and income levels, these are heavily skewed toward the middle class on up.  The truth is that almost everything is going in the wrong direction. 

  • Housing sales are tanking as rates rise
  • While better than last year, gas is still high and will go higher because of our need to refill the strategic oil reserve
  • Food prices are still high, and the cost of labor is still working its way to the consumer
  • Consumer credit card debt is rising, and we know that is normally followed by defaults or bankruptcies
  • Money from all the government Covid giveaways is running out

We reported in another article titled BRICS and YEN on the desire of a five-nation group to replace the U. S. Dollar with a “basket” of currencies.  Even if this proves to be only for those five nations, it will influence the dollar strength.  China and Russia have been pushed ever more in this direction by the War in the Ukraine, and Russia is only taking Rubles and Yuan in international settlements.  With China as a large trade partner this should be unsettling since they could begin requiring us to pay for goods in Yuan, driving up the Yuan and down the Dollar.  China and Russia have also added to their gold reserves in the past year by significant amounts.

As of January 6, 2023, our national debt is now at $31.4 trillion dollars.  Our President and Congress just agreed to add another $1.7 trillion to the total without batting an eye.  According to our debt now averages about $247,000 per taxpayer, a sum that is not recoverable through taxes without destroying the nation.  With an average family income of $36,000 these are figures that just become background noise, exactly where politicians want them.  The interest on the national debt is now approaching $516 billion annually but will need to go much higher as the FED raises rates in its attempt to curb inflation.

2023 is going to be an interesting year as world financial issues begin to unfold and we can draw a sharper focus on the real events that will affect our lives.  In our next installment we will look at the FTX failure and speculate on what one might conclude from just the organization chart now widely circulating.

By design we do not allow direct comments on articles on our web site.  But this is one where we would like to see either opposing or supporting discussions.  For something this inconspicuous to have the potential for such an impact on all our lives seems unreal.

DISCLOSURE: This commentary is being communicated as general information and observations only and should not be taken as investment advice.  It is not investment research or a research recommendation, as it does not constitute material research or analysis.  The actions that you take as a result of information contained in this document are ultimately your responsibility.