European Union Debt Crisis Stings France, Putting U.S. Banks at Risk

While investors in the United States have been preoccupied with the debt-ceiling crisis and volatile stock markets, the European Union debt crisis has worsened.

Now France is under suspicion, and if its debt troubles spiral out of control, then there's a good chance the country will take U.S. banks down with it.

Despite denials from the major ratings agencies, some believe France could be in danger of losing its AAA credit rating, just as the United States did recently.

In fact, it was Standard & Poor's unprecedented downgrade of the United States that put investors on notice that no nation was safe. France became a target because many of its large banks hold a lot of debt from troubled nations like Greece, and because France has a lot of debt of its own.

The cost of insuring French sovereign debt via credit default swaps edged up last week as rumors swirled and concerns accelerated.

French sovereign debt has grown alarmingly quickly, rising from just 64% of its gross domestic product (GDP) in 2007 to 85.3% of GDP this year, according to International Monetary Fund (IMF) estimates.

A weakening French economy – on Friday the French statistics office reported that second quarter GDP growth was zero – and inadequate government policies have added to investor jitters about the country's ability to repay its debt.

"We've been really cautious, and the sovereign crisis is now escalating," Philip Finch, global bank strategist for UBS AG (NYSE: UBS), told The New York Times. "It boils down to a crisis of confidence. We haven't seen policy makers come out with a plan that is viewed as comprehensive, coordinated and credible."

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U.S. AA+ Credit Rating Downgrade: Here's The Worst-Case Scenario… And How To Protect Your Wealth

If there's a "worst-case scenario" for this whole credit downgrade, this is it.

U.S. stocks have plummeted with the Standard & Poor's downgrade, but the final results of the AA+ credit rating could be much, much worse.

After studying everything that could happen due to the downgrade of the United States' top-tier AAA credit rating, and the potential default on its debt, we found a scenario that would result in forced asset sales so widespread that global stock-and-bond markets would plunge – and economies around the world would crash.

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Why a U.S. Default Will Be a Good Thing

Now that Standard & Poor's has finally slashed its U.S. credit rating, it's more apparent than ever that a U.S. default is imminent.

So if you're at all panicked by S&P's decision to downgrade the country's top-tier credit rating – and the resultant freefall in U.S. stock prices – brace yourself: It's going to get a lot worse before it gets better.

But make no mistake, it will get better.

In fact, at this point, a U.S. default is the only conceivable remedy to our debt affliction.

Here's why …

The Wrong Road

The United States has been able to coast on its top -tier credit rating for far too long. The truth is, this country stopped being a AAA credit risk in early 2007.

That's when the Bush administration's excess spending and military forays into the Middle East sent us down the wrong road and ultimately drove the fiscal 2008 federal deficit to more than $400 billion. That's despite the fact that the economy was at the top of an economic boom at the time.

It's true that our fiscal position has grown substantially worse since then, but that's mainly because of the G reat R ecession of 2008-09.

Even if an imaginary amalgam of Calvin Coolidge and Bill Clinton had been in the White House since 2008, inheriting the overspending already built into the system, the federal deficit still would have reached $700 billion to $800 billion over the last few years.

Just the bailouts of Fannie Mae, Freddie Mac, General Motors Co. (NYSE: GM) and Chrysler would have added enough to the structural costs of recession to push the arithmetic off kilter.

The Bush administration's additional spending in 2008, U.S. President Barack Obama's $800 billion-plus of "stimulus," and the g rotesque addiction that Congress continues to have to subsidies for farmers, ethanol, and idiotic "green" energy projects have all made the position worse. But they only account for about half of the annual deficit.

Of course, while recent political decisions don't bear much responsibility for the current lousy U.S. position, our current crop of politicians have been – and will continue to be – ineffective in their attempts to emerge from it.

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Gold Prices Hit Record High After S&P Downgrade – Are Poised to Double

Gold prices hit a record high of $1,718 an ounce in intraday trading yesterday (Monday) in response to Standard & Poor's downgrade of the U.S. credit rating, and the continuing drumbeat of dreary global economic news will keep pushing the yellow metal higher.

In fact, Money Morning Contributing Editor Peter Krauth reiterated his belief that gold prices will more than double from current levels.

"I expect gold to reach $5,000 before this bull market peaks," Krauth said. "I'm very open to the possibility that gold could correct from here, but I'd expect that to be nothing more than a short-term pullback."

Following through on a months-long threat, S&P cut the U.S credit rating to AA+ from AAA late Friday, sending global stock markets tumbling and a flood of investors to one of the few safe havens available – gold.

"The S&P downgrade adds to concerns that investors have in the safety of U.S.- issued debt," Krauth said, pointing out that Treasuries are "considered to be the safest in the world because of their previously unblemished AAA rating and their liquidity. When doubt is cast on such an important and ubiquitous investment instrument, it's no surprise that gold, a traditional safe haven dating back millennia, is going to be a beneficiary."

Although it had already risen 15% for the year as of Friday, the appeal of gold remains high among investors worried about sovereign debt problems in the United States and Europe, as well as a U.S. recovery that looks like it may tip into a double-dip recession.

"The surge in gold is a knee-jerk reaction to the downgrade and could prompt profit-taking, but concerns of slowing economic activity in the U.S. and the lack of concise action to tame its debt levels will likely see more diversification from U.S. assets, boosting demand for the ultimate safe haven," FastMarkets analyst James Moore told the Wall Street Journal.

Gold on the Comex division of the New York Mercantile Exchange soared $66.40, a 4% pop, in overnight electronic trading Sunday night to a record $1,718.20 an ounce. After slipping below $1,700 in the morning, S&P's follow-up announcement that it had also downgraded the credit ratings of mortgage giants Fannie Mae and Freddie Mac drove gold to $1,715.50 by 4 p.m.

Yet gold remains well below its inflation-adjusted peak set in 1980, when it sold for $850 an ounce – the equivalent of about $2,400 an ounce today.

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Don't Look Now but the National Debt Could be $23 Trillion by 2021

There was a lot of back-patting in Washington this week after U.S. President Barack Obama signed a debt-ceiling deal that he and members of Congress claim will reduce the national debt.

But here's the truth: This deal does nothing to reduce America's debt burden. In fact, the $14 trillion we owe now could every easily exceed $23 trillion by 2021.

That's a 62% increase.

It only takes a little bit of number crunching to see what I mean.

The deal brokered by Congress cuts spending by just $917 billion over a 10-year period, with a special congressional committee assigned to find another $1.5 trillion in deficit savings by late November.

Even if you round up, that $2.5 trillion in "savings" over a 10-year period is inconsequential when you consider that President Obama added nearly $4 trillion to the national debt in just a few short years in office.

How can you make any progress on the debt front when you're adding $4 billion in new liabilities every day?

And the story is even worse than that: According to the Congressional Budget Office (CBO), even the $2.5 trillion the government claims to be saving is quickly vaporized by inflation and lost economic output.

CBO: Contrary to Barack Obama

The CBO in January estimated that a 0.1% reduction in growth rates would increase the deficit by $310 billion over the next 10 years, while a 1% increase in inflation rate would increase the deficit by $867 billion.

The CBO projects the average growth rate from 2011 to 2016 will be 3.25%, and the non-partisan group has the average rate of inflation pegged at 1.55% over that same period.

However, growth in the first half of 2011was 0.8% and the personal consumption expenditures (PCE) inflation index – the type of inflation the CBO looks at – was 3.5%.

So let's do the math.

If growth and inflation statistics magically revert to CBO expectations – which would be a long shot considering how much they're already off – then the budget deficit over the next 10 years would rise by $928 billion. That alone is more than enough to wipe out the $917 billion of initial savings in the debt-ceiling bill.

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A Toothless Debt Deal Won’t Stop a U.S. Credit-Rating Downgrade – Or the Aftermath that Follows

It's often said that the sign of a good compromise is that both parties walk away dissatisfied – but that's not necessarily true of the debt deal Congress is close to passing.

To be sure, both parties are dissatisfied with the outcome of this contentious battle. Progressive Democrats are disappointed that planned cuts to government spending won't be augmented with tax increases, while fiscally conservative Republicans are angry that the cuts to spending haven't gone far enough.

But the truth is, regardless of their party allegiances, all Americans should be disappointed in their policymakers for the same exact reason: After months of political kabuki theater, the debt deal that's working its way through Congress is toothless, ineffectual and will do little or nothing to prevent a crushing blow to the markets and the dollar.

The facts of the debt deal are as follows:

  • The deal raises the debt ceiling by $900 billion to $17.7 trillion.
  • It cuts spending by $917 billion over the next decade and a special congressional committee will be assigned to find another $1.5 trillion in deficit savings by late November.
  • If Congress comes up with the savings, or passes a balanced-budget amendment to the constitution, the government will accrue another $1.5 trillion boost the debt ceiling – sufficient to pay the country's bills through 2013.
  • If Congress fails, the president will be granted a $1.2 trillion debt-ceiling extension – but automatic, government-wide spending cuts (half of which will come from the defense budget) will take effect in 2013. There will be no automatic tax increases.

The United States at least may have will have avoided default, but the country is still enrapt in debt and likely to incur a credit-rating downgrade.

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The Secret Way to Profit from the U.S. Debt to China

Perhaps the biggest reason our country is facing a contentious debt-ceiling debate is because of the massive U.S. debt to China.

It's easy to forget that China is the world's largest buyer of U.S. Treasuries and it has as much to lose in this high-stakes game of chicken as does the United States.

Indeed, China's rapid growth over the past decade has resulted in a new paradigm.

Go back 10 years, and nobody worried about the U.S. debt to China. No one ever talked about the Chinese yuan replacing the dollar as the world's reserve currency. Or wondered whether the U.S. would ever owe China more than it could possibly pay.

And why would we ever worry about China?

At the time, the U.S. was the biggest economy in the world, with the most powerful markets and currency. When we walked into a G-7 meeting, we were used to getting exactly what we wanted. We said "jump" and the rest of the world said "how high?"

Back then, China wasn't even invited to those meetings.

But as you know, things have changed – even if the average American politician and citizen doesn't want to admit it.

We can no longer burst into a G-20 meeting and simply demand what we want. We must contend with the demands of China – the freshly minted economic superpower that happens to be our largest creditor.

Who's the Boss?

China has grown to be the second largest economy in the world now. And how did they grow rich?

Simple: They've saved while we spent. They invested while we went into debt. They went without while we lived beyond our means. We expanded and issued bonds to pay for our debt. China bought up those bonds and earned huge sums of interest off of us.

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How the Debt-Ceiling Debacle Will Spark a Short-Term Drop in Gold Prices

I'm an avowed gold bull, and I truly believe that gold investors will end up benefiting from the biggest bull market of our time.

But we have to be honest: Investor psychology plays a crucial role in shorter-term investment results. And recent trading patterns clearly demonstrate that most of the recent increase in the price of gold is due to the debt-ceiling debate in Washington, as well as the European sovereign-debt crisis that continues to lurk in the background.

The bottom line: The debt-ceiling debacle could cause a short-term drop in gold prices.

Congressional leaders as of early Sunday afternoon had yet to reach a debt-ceiling deal, but said they were close to an agreement that they hoped would prevent default.

As of late Thursday, gold was trading within 1% of the all-time high of $1,628.05 reached on Wednesday, and was poised to record its first monthly increase in three – all because of the debt-ceiling deadlock and the fear that a U.S. government default would level the global financial markets. Spot gold has surged 7.6% in July.

If you think about it, a number of things just don't add up. For instance:

  • The 30-year U.S. Treasury bond is yielding just 4.31% – meaning the rate is virtually unchanged since the start of the year. But with Standard & Poor's saying there's a 50% chance it will downgrade the United States' top-tier AAA credit rating – something once considered bulletproof – you'd expect that yield to be surging as "rational" investors dump U.S. debt. Right?
  • In fact, a quick glance at yields on the one-month, one-year, two-year, five-year, 10-year, 20-year – and every maturity in between – shows that yields are down from the start of the year, meaning investors are still buying U.S. Treasuries, despite record deficits and the fast-approaching debt-ceiling deadline. If there's a risk of a downgrade and a default, shouldn't those same "rational" investors be avoiding all new purchases, even as they dump current holdings?

So what will we see if tomorrow's (Tuesday's) deadline comes and goes, and no deal is reached down on Capitol Hill?

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How Investors Should Prepare as the Debt-Ceiling Deadline Approaches

U.S. President Barack Obama earlier today (Friday) addressed the nation about the debt-ceiling deadline, urging Congress to find a way "out of this mess" – something investors have made repeated pleas for. The lack of progress on the debt-ceiling debate has angered many investors who find themselves in a frighteningly uncertain position. "What's happening in […]

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U.S. Debt Ceiling: How To Protect Your Wealth From The Debt Ceiling Increase

U.S. Debt Ceiling: How To Protect Your Wealth From The Debt Ceiling Increase If Congress and President Obama can't agree on a U.S. debt ceiling increase, it could cause an unmitigated economic disaster – one so unprecedented that government and private analysts can't even accurately figure out all the potential consequences. To avert this crisis, […]

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