Detroit goes bust – is Europe next?

Detroit, Motor City, Motown… one of the most storied cities in America has just filed for bankruptcy. And we could be about to witness the biggest US municipality bust ever, leaving debts of some $20bn owed to 100,000 creditors unpaid. That’s five times the size of the previous largest municipality bust: Jefferson County, Alabama in 2011.

It’s easy to read a news story like “Detroit files for bankruptcy”, and think it’s got nothing to do with us. But it does.

Because if you look closely, there are some disturbing parallels between Detroit and our southern European neighbours.

And I’m growing increasingly concerned that peripheral Europe could soon sink into a bust that will echo the devastation that we have seen in Detroit…

‘There just isn’t anyone left to kill!’

In many ways, this story has been a 60-year-old accident waiting to happen. As the motor industry went into decline, Detroit’s population plummeted from around two million in the ’50s to 700,000 today.

Those that can work have moved away; many of those that can’t, or won’t work have been left behind. The finances have got so bad that even the city’s public workers have been chucked out on the dole. In the last ten years, the police force has been cut by 40%. Much of the city lies desolate – with wild boar and pheasant returning to the empty streets that motor workers have left behind. When mayoral candidate Stanley Christmas was recently asked to account for a 14% drop in homicides, he told reporters, “there just isn’t anyone left to kill!”

But as apocalyptic as this sounds, this mass exodus reminds me of somewhere closer to home…

The real reason why great cities fail

Recently, the French press has been increasingly reporting the worrying trend in emigration. They are concerned about the great drain from peripheral Europe to London. And I’m sure you’ve noticed this yourself. Where in the past the cafes were almost entirely staffed by eastern Europeans, today, it’s just as likely you’ll be served by a Cypriot, Greek, or Spanish waiter. These migrants have fled countries that will be mired in debt for decades.

It was the same in Detroit. The city has been racking up debt, both on and off the balance sheet for decades. And the creditors have been closing in.

I think we will see the same story play out in Europe. Just like Detroit, southern Europe can issue debt – in the States, they call these things ‘muni-bonds’ – and in Europe, we call it sovereign debt.
But the thing is, neither Detroit nor southern Europe can issue currency. And that’s the problem!

The state of Michigan (wherein Detroit lies) has long-since relinquished any right to create currency; it’s all part of the Federal Reserve system… and the Fed only seems interested in bailing out banks – not municipalities!

And any country that joined the eurozone similarly gave up the right to create currency. Sure, they can create debt… but that’s not the same thing! And again, the planners’ plan seems to be, let the nation states go bust… but make sure the banks hang on in there.

With the yields on government debt climbing across Europe, I think we need to consider the fact that some nations are slowly, but very surely going bust. Against all odds, the planners have avoided the sudden panicky end for the likes of Greece and Portugal. But as far as I’m concerned, the panicky, fast bit of the bust is looming. And that could be very bad news for British banks…

Because, make no mistake, British banks are still heavily exposed to this threat. Household names like Lloyds TSB and RBS are poisoned by billions in toxic European debt. That’s why they could be among the worst hit. And they won’t be alone. Take a look at the chart below from McKinsey and the European Banking Authority…

UK banks and eurozone debt exposure chart

This is a chart that was passed on to me by Tim Price. As you can see here, UK banks are in a precarious position, holding billions of toxic debt from crisis hit European nations. If the situation in Europe takes another downturn – and given the financial insolvency of so many countries – Tim and I both believe it is a matter of when and not if – this unexploded debt bomb could ignite.

Britain’s saving grace

How do we get out of this mess? Well, in the UK, the Bank of England is pursuing its own exit strategy by printing money. In my opinion, this is just another way of defaulting. But it’s one that doesn’t need a court to ‘allow’ the municipality/nation, or whoever, to bust itself.

You’ve got to stand back and admire the ruse. The Bank of England has bought up about a third of the outstanding UK debt pile… not bad! And as I said on Friday, I would think they’re going to have to take on a whole lot more.

The great benefit of the printing and inflation strategy is that the planners don’t need to renegotiate terms with the likes of pensioners, boldholders and key workers. And hence, we’ve avoided much of the grisly street protests and general ill feeling inflicted on so many southern Europeans.

But make no mistake, there is an inflation tax at work here. In fact, it’s the subject of a book out last week by Pete Comley – I’ve been poring over it for the last few days… it’s certainly very illuminating – if not worrying! And I’ll talk to you more about it soon.

Here at The Right Side, we’ll continue to work out ways to avoid this pernicious tax. But for the moment, let’s share a thought for the citizens of Detroit… and perhaps too for those nations of southern Europe that are drawing nearer to a similar fate.