In my December 26 Money and Markets column I focused on the outlook for 2010, and the looming threats to global risk appetite. I warned that sovereign debt problems posed a major threat to global economic recovery. And I concluded that this threat represented a catalyst for a return of global risk aversion.
I also said that in a global crisis, these sovereign debt fears have the ability to be contagious. Such fears can destroy investor confidence in the capital markets of troubled countries, as well as in the overall global economy.
And when confidence wanes, capital flees … a surefire recipe for falling dominoes. That's especially true in the wake of a deep global recession that has left many countries with bloated deficits and debt loads.
Despite the European leadership's attempt to lessen the sense of urgency in the euro zone and despite the ambitious plans rolling out to shave outsized deficits, the problems with governments' finances are not finding a resolution.
More likely, it's just the beginning of another major destabilizing force for the global economy. And the result is looking more like another bout with recession … or perhaps depression.
Here's a brief look at how the dominos are setting up to fall, and ultimately why I think the British pound is the next vulnerable currency, as fear and instability spread from country to country.
Falling Domino #1:
Dubai, the Wakeup Call
In late November the Dubai government created a hiccup in the rosy plans that many market participants were increasingly hitching their wagons to: A V-shaped economic recovery.
All of the sudden the new, innovative center for global finance was in default. And contrary to what was assumed, its rich neighbors weren't there to provide a lifeline.
Now Dubai World's debt holders are getting only 60 cents on the dollar for their government bond investment.
Falling Domino #2:
Greece, Next in Line
Greece, the weakest of the sixteen-member European monetary union, the euro, was running a budget deficit more than four times the limits set forth in the euro-zone's fiscal constraint guidelines.
The ratings agencies took the alert from Dubai. And they started slashing Greece's sovereign debt ratings sending out a warning signal to all debt holders and making Greek government debt refinancing that much more difficult.
Falling Domino #3, #4 and #5:
Portugal, Ireland and Spain
The Next Troubled Spots
Greece isn't the only euro-zone country in trouble … Portugal, Ireland and Spain all have severely bloated deficits and debt levels.
