As most people will tell you, the best and easiest way to swallow an elephant is in bite sized chunks. But this is easier said than done when it comes to the huge amounts of sovereign debt that some countries and banks will have to refinance in 2011.

Many of the debts that some countries and banks incurred through the issuance of bonds will need to be repaid and further bonds issued to replace that money. In essence a roll-over of debt.

But it is the volume of that debt roll-over that is causing concern. European governments need to find €500 billion (€85 billion of which is Spain's alone) and the banks need to raise €400. That's €900 in total (or £772 billion). That's one big elephant to swallow!

A new eurozone crisis is the top prediction of the Centre for Economic and Business Research (CEBR), which says that just Spain and Italy have to refinance a staggering €400 billion.

One would think that governments would issue bonds to finance a particular project that would give a positive boost to the economy to bring in extra taxation so that the bond debt could be repaid. But it seems that we now need this debt just to operate on a day to day basis (ie without it the country would collapse). Some governments have found how easy it is to borrow and spend when it's someone else's money.

When a government (or a bank or business for that matter) issues a standard bond (the UK government form is called a 'Gilt') it receives a lump sum from the new bond holder on the understanding that interest is paid to the bondholder and the full lump sum given back when the bond expires. It is therefore an interest only loan, during the life of the bond none of the principal debt is repaid.

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It is therefore in the interest of the issuer for inflation to erode the value of the interest and lump sum due over time (unless it is an index linked bond of course, which is rare). But with inflation comes greater risk to the bondholder who will want a greater return so borrowing becomes more expensive. Not only that, if the economy looks unhealthy then the returns will have to be still greater again, that is until the risk gets great enough to scare everyone away.

There are now fears that many countries and banks will be unable to refinance their debts in the middle of 2011 leading to a further credit crisis.

But this is not isolated to the EU. In some peoples' eyes the USA has a far greater problem. There are rafts of cities and even states within the USA that may find it nigh on impossible to refinance their municipal debts, with bankruptcy being their only way out. The Guardian has reported that this could mean $2 trillion and 100 cities, including California [1] ($25 billion shortfall)! The US banks are also in dire straits with the Wall Street Journal saying that the once bailed out banks are again on the slippery slope to failure.

So, it's not just one elephant, it's a whole herd of woolly mammoths on a stampede!

We could well see a race to refinance starting very early in the year with the late-comers finding the table bare when they do get there. This will force the cost of borrowing up for everyone as well as devaluing the tax we all pay. Many investors may become bond wary (or weary) and look elsewhere to invest. But there are not many safe havens left outside of gold and silver.

This will not be pretty.


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