From David Stevenson, across the river from the City

Last week was just like 2008 again. The FTSE 100 was up 2.5% on the week by mid-Wednesday, only to fall by almost 5% before Friday’s close.

There were plenty of things to blame the poor performance on. We had some poor jobless figures in the US. Then of course there’s the fast-growing eurozone debt crisis. Greece might be in the biggest mess, but other borrowers in the region are also coming under the microscope.

But the bad news is that this isn’t just about a few peripheral eurozone countries, or some dodgy unemployment stats. There are plenty more global debt time bombs primed and ready to explode.

The ultimate damage to the financial system could make 2008 look like a walk in the park. Don’t touch government bonds with a bargepole. Here’s why...

Bad debts are set to hammer banks

The economic boom that ended in 2007 always seemed too good to be true. That’s because it was. It was built on borrowing, much of it personal. In the UK, the ratio of household debt to disposable income hit its highest-ever level of 160% by mid-2008, according to the Office of National Statistics.

Now the game’s changed completely. Incomes have been squeezed by rising job losses and the economy going wrong. Apart from at Christmas times, consumer loan growth has been declining in almost a straight line for the last two years. In fact, credit is now contracting.

But there are still millions of over-indebted Britons. And many are now finding it too difficult to make ends meet. In 2009, 134,000 people in England and Wales went into some form of personal insolvency. That’s the highest-ever recorded figure and up 26% on 2008. “The huge number demonstrates the real effect the recession is having on the average person in the UK”, says Pat Boyden at accountancy group PwC.

British banks had to double their credit card write-offs in 2009’s third quarter. And things could be about to get much worse. “Expect to see growing numbers of personal insolvencies over the next 12 months”, says Steve Rees at debt advisers Vincent Bond. That will mean banks facing bigger bad debts, and even less credit card lending.

In short, it’ll be very nasty. But this is small beer compared to some of the debt time bombs that are ready to go off around the rest of the world.

Greece's problems are nothing compared to the global picture

It isn’t just British consumers who’ve taken against debt. Private borrowing is slowing everywhere. US consumer credit has shrunk for a record 11 months in a row.

But governments round the world have been aggressively picking up the slack. Since the collapse of Lehman Brothers in September 2008, the G20 – the 20 largest industrialized countries – has spent more than $2.2 trillion to try to get global growth going again. Much of this money has been borrowed. That’s just adding to the debt pile those governments had built up earlier.

Sure, financial markets are fretting that within two years, Greece will have racked up public borrowings equal to more than 120% of GDP. But that’s nothing compared to the global picture. Dylan Grice at Société Générale has crunched the numbers for the whole of the EU, the UK and the US. He’s found that the average total net liabilities - including unfunded pensions, social security and healthcare - of these countries’ governments emerged at a terrifying 400% of GDP.

“After the stimulus binge, it’s a debt hangover”, as William Pesek puts it in BusinessWeek. Even if governments stop overspending now, they’ll have to compete more for cash with the private sector. So they’ll have to pay much higher rates on the bonds they’ll need to sell.

This will drive up the cost of capital for everyone. That in turn will curb private sector investment. Without that investment, we won’t get the levels of economic growth required to generate the taxes that governments need to keep debt at manageable levels. Life will also get even harder for heavily-borrowed individuals. It’s a truly vicious circle.

So things look bad, even if governments stop overspending now. But the trouble is, they won’t stop over spending. Paul Farrell at Marketwatch has been digging deeper into America’s debt mountain. He spotlights a range of areas, such as homeland security, defence and local government, where spending is fast overshooting. The only way the US authorities will be able to plug the financial gaps will be to borrow even more money.

“Deficits are like putting dynamite in the hands of children”, says Nicholas Taleb, author of The Black Swan (which showed how history is littered with rare and unpredictable events). “They can get out of control very quickly”. No wonder he’s urging “every single human being” to bet on US Treasury bond prices falling – which would happen automatically if yields are pushed up.

So what’s the bottom line?

Keep well clear of UK, US and European government bonds. And remember that soaring bond yields will be very bad news for the prices of cyclical shares that depend on economic growth. That’s why we keep suggesting defensive stocks, which don’t.

Farrell believes “the third great Wall Street meltdown of the 21st century is coming, which will ignite the Great Depression that has been simply delayed by the stimulus bonanzas and bailouts”.

Maybe that’s a bit of an apocalyptic view – we’ll see. But there’s no doubt the markets will soon be facing some vastly bigger debt problems than just those of Greece.

Until next time,

David Stevenson

Turning to the markets...

The JSE all share index advanced 1.59% yesterday. The gold mining index gained 0.75%. Resources added 2.35%. Banks and financials grew 2.92% and 1.69% respectively. Industrials bounced 0.75% and the platinum mining index jumped 1.55%.

London's FTSE100 climbed 0.38%. The Dow Jones collected 1.52% and the Nasdaq closed up 1.17%.

Tokyo's Nikkei gained 0.63%. Hong Kong's Hang Seng traded flat, down 0.04%.

Brent crude is currently trading at $71.62 per barrel.

Spot gold's trading at $1,075.40 and platinum was last quoted at $1,498.50.

And here's how the rand is performing against the major currencies:
R/$7.70
R/₤12.06
R/€10.58