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Morgan Stanley analyst Arnaud Mares thinks there's little chance that major economies will default on their sovereign debt. But in an intriguing analysis, he says there are other ways for bondholders to get whacked, especially what he calls “financial oppression.”
His analysis goes like this: the government debt problems of the U.S. and Europe are even worse than commonly understood. That's because the debt is usually measured as a percentage of gross domestic product and the U.S., at 53%, or France at 77.6% doesn't seem that lousy.
But that's a flawed stat, he says, because it doesn't compare debt to a government's ability — or willingness — to pay. When measured against government revenue, the U.S. debt position, for instance, is worse than Greece's.
Thus far, though, holders of government debt have been spared haircuts largely because no country has wanted to undermine its ability to borrow more and — Mr. Mares doesn't cite this — the International Monetary Fund has stepped into the breach.
But he notes “outright default is not the only way to impose losses on creditors.” There's always “financial oppression,” meaning negative rates of return. That can be accomplished by repaying debt in devalued money, or via taxation or regulation.
There are plenty of such examples, including post-war inflationary episodes in France, Britain and the U.S.
Making such an outcome likely, he says, are the diverging interests of bondholders — to get paid — and the most powerful political constituents in the U.S. and Europe: the elderly. Aging baby boomers may hold government debt in their portfolios, but their real interest is to make sure the government pays for social security and healthcare.
When push comes to shove, he figures, governments will put powerful voters ahead of powerful creditors. “The interests of bond holders are no longer perfectly aligned with those of the most powerful constituency,” he writes.
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Couple Mares’ report with the overlooked GAO-10-899 that came out this month, and one message comes through loud and clear: Governments at all levels must act immediately or plunge over a fiscal event horizon from which there is no return. http://www.franklincenterhq.org/1890/gao-state-local-governments-%e2%80%98will-steadily-decline%e2%80%99/
The issue is government promises and the debt together. Our economy is around $14T our debt $13T, Present value of future unfunded liabilities: Social Security $13T, Senior Drug Benefit $13T, Other Medical without Obama Care $50T, Pensions ??? Let’s say the total is $100T. At 3% interest ($3 T) it would absorb more than all current Federal Revenues. Politicians have promised us the moon and will not and cannot deliver. We are destroying the future for all the young and the working people. The older generation will collect their benefits. This does not include the debts of State and Local governments and their unfunded pension and medical liabilities. The sovereign debt crisis is just getting started and will affect several European countries and Japan has no way out. Many say that Japan is not a problem because the debt is held in Japan. That makes the problem worse because you are destroying the wealth of the entire economy. The crisis has lowered their stock market by 75%, Real estate by 60 to 70% over a 21 year period and now it will take much of their conservative savings as the government inflates, reschedules or defaults. Japan has about $20T of bank deposits vs about $8T in the United States. At a blended cost of 1.4%, interest absorbs 25% of current government revenues, at 2.8% it would be 50%. Government borrowing is more than 50% of current spending. Much of the debt is held in Japan Post (largest financial institution in the world), banks, insurance companies and also by the people. The savings rate has gone to zero and the two largest holders of Japanese Bonds are now sellers. These financial institutions would all go broke if the government tried to print the money because the bonds they hold would lose significant value. There is no way to sell the bonds overseas unless interest rates were more competitive and they would have to prove that they could pay the money back to a foreign creditor. They have tried a Keynesian approach and it has failed. It is the largest wipeout of wealth ever in the history of the world and their huge savings/bank deposits are in the process of being wiped out by a government. that has not properly funded its obligations and is broke. Politicians cannot properly manage finances because they are in the business of “buying votes”. All levels of government should be mandated to publish comprehensive annual balance sheets with the present value of all unfunded liabilites and the plan of how they will be financed. All Budget increases (not inflation adjusted) should require a 60% approval. Spending limits should be in place as a % of GDP or a $ limit adjusted for inflation and population, etc. Do not depend on the current system or it will destroy our wealth. You will see how this plays out. First watch Greece and then how it moves through other weak countries and then to Japan, the most indebted of them all. We are all on notice that what we have been doing is not sustainable and that Keynesian theory does not work when you have a structural problem. We need to cut the cost of government at all levels and be more competitive against foreigners (less imports and more exports). Government is a cost of doing business and must become more efficient if we are to see the economy improve for our children.
Gray – any debt (public or private) has the same effect, just not as direct. But it’s with everything. Reduction has the opposite effect.
Sir - Thanks for pointing out my anachronistic remark - I know I’ve seen you somewhere - is that you 3rd from the left in the group photo of “The Last Supper” ?
“…he'll more likely wind up like Geo W Bush, just another national digrace…” Sorry to clue you in, but the Bush-bashing is so yesterday. Other than his foolish ideas that Islam was the religion of peace and America needed open borders and free trade, he wasn’t that bad. Since he left office his successor, the Big O, has already put in two Supreme Court justices who will continue to shred the Constitution. That’s the true national disgrace.
Real Time Economics offers exclusive news, analysis and commentary on the economy, Federal Reserve policy and economics. The Wall Street Journal’s Phil Izzo and Sudeep Reddy are the lead writers, with contributions from other Journal reporters and editors. Send news items, comments and questions to realtimeeconomics@wsj.com.
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