The Developed World Will Default on Its Debt: Opinion

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( TheStreet) -- There are three primary factors that determine the interest rate a nation must pay to service its debt in the long term: the currency, inflation and credit risks of holding the sovereign debt.

All three of those factors are very closely interrelated. Even though the central bank can exercise tremendous influence in the short run, the free market ultimately decides whether the nation has the ability to adequately finance its obligations and how high interest rates will go.
The Federal Reserve

An extremely high debt-to-GDP level, which elevates the country's credit risk, inevitably leads to massive money printing by the central bank. That, in turn, causes the nation's currency to fall and increases the rate of inflation.

It is true that a country never has to pay back all of its outstanding debt.

However, it is imperative that investors in the nation's sovereign debt always maintain the confidence that it has the ability to do so.

History has proven that once the debt-to-GDP ratio reaches about 100%, economic growth grinds to a halt.

The problem is that the debt continues to accumulate without a commensurate increase in the tax base. Once the tax base can no longer adequately support the debt, interest rates rise sharply.

Europe's southern periphery, along with Ireland, has hit the interest rate wall. International investors have abandoned their faith in the bond market, and these countries have now been placed on the life support of the European Central Bank. Without continuous intervention of the ECB into the bond market, yields will inexorably rise.

The U.S. faces a similar fate. Our debt is a staggering 700% of income. And our annual deficit is more than 50% of federal revenue.

Imagine your annual salary is $100,000 and you owe the bank a whopping $700,000. Then you tell your banker you are adding $50,000 each year -- half of your entire salary -- to your accumulated debt.

After picking themselves off the floor, your bankers would summarily cut up your credit cards and remove any and all existing lines of future credit.

Our gross debt is $15.6 trillion, and that is supported by just $2.3 trillion of revenue. And we are adding more than $1 trillion each year to the gross debt. Our international creditors will soon have no choice but to cut up our credit cards and send interest rates skyrocketing.

When bond yields began to soar towards dangerous levels in Europe back in late 2011 and early 2012, the ECB made available more than 1 trillion euros in low-interest loans to bail out insolvent banks and countries.

Banks used the money to plug capital holes in their balance sheets and buy newly issued debt of the EU nations.

That caused 10-year yields for Spanish and Italian debt to quickly retreat to less than 5% from their previous levels around 7%.

But now that the ECB isn't printing any new money, yields for those two nations are quickly heading back toward 6%.

There just isn't enough private sector interest in buying insolvent European debt at the current low level of interest offered.

The sad truth is that Europe, Japan and the U.S. have such onerous amounts of debt outstanding that the hope of continued solvency rests completely on the perpetual condition of interest rates that are kept ridiculously low.

It isn't so much a mystery as to why the Federal Reserve, ECB and Bank of Japan are working overtime to keep interest rates from rising.

If rates were allowed to rise to a level that could bring in the support of the free market, the vastly increased borrowing costs would cause these economies to falter and their deficits to skyrocket. This would eventually lead to explicit defaults on debt.

But the key point here is that continuous and massive money printing by any central bank eventually causes hyperinflation, which mandates yields to rise much higher anyway.

It is at that point where a country enters into an inflationary death spiral. The more money it prints, the higher rates go to compensate for the runaway inflation. The higher rates go, the worse economic growth and the debt-to-GDP ratio become.

Those factors put further pressure on rates to rise and on the central bank to increase the amount of debt monetization. And so the deadly cycle repeats and intensifies.

The bottom line is that Europe, Japan and the U.S. will eventually undergo massive debt restructurings the likes of which history has never before witnessed.

Such defaults will either take the form of outright principal reduction or intractable inflation.

History shows that ownership of gold will provide a safe harbor for your wealth when paper currencies are being inflated into oblivion.

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