Skip to comments.Sovereign Subjects: Ask Not Whether Governments Will Default, but How
Posted on 08/25/2010 7:41:29 AM PDT by jpl
This is the first issue of Sovereign Subjects, a new Morgan Stanley publication focusing on sovereign risk in advanced economies. In this first installment, we take a broad perspective on government balance sheets and raise several themes to which we will return in more depth in subsequent issues. We encourage clients to provide us with feedback on this new publication.
Debt/GDP ratios are too backward-looking and considerably underestimate the fiscal challenge faced by advanced economies governments. On the basis of current policies, most governments are deep in negative equity.
This means governments will impose a loss on some of their stakeholders, in our view. The question is not whether they will renege on their promises, but rather upon which of their promises they will renege, and what form this default will take.
So far during the Great Recession, sovereign (and bank) senior unsecured bond holders have been the only constituency fully protected from partaking in this loss.
It is overly optimistic to assume that this can continue forever. The conflict that opposes bond holders to other government stakeholders is more intense than ever, and their interests are no longer sufficiently well aligned with those of influential political constituencies.
There exists an alternative to outright default. Financial oppression (imposing on creditors real rates of return that are either negative or artificially low) has been used repeatedly in history in similar circumstances. Investors should be prepared to face financial oppression, a credible threat against which current yields provide little protection.
The sovereign debt crisis is not European: it is global. And it is not over. The European sovereign debt crisis of spring 2010 was a misnomer in more ways than one: there was not one crisis but two. And it will continue well beyond 2010, in our view. The first crisis was, and remains, an institutional crisis of the euro, caused by a flawed multilateral fiscal surveillance framework. Steps have been taken towards a correction of the flaws with a move from peer pressure to peer control of fiscal policy. This is reflected by the acceptance by the Greek, Spanish and Portuguese governments of fiscal measures largely dictated from Berlin and Brussels. The second crisis was, and remains, a sovereign debt crisis: a crisis caused by sovereign balance sheets being overstretched, to the point where insolvency ceases to be merely possible and becomes plausible. This crisis is not limited to the periphery of Europe. It is a global crisis and it is far from over. We take a high-level perspective on the state of government balance sheets and conclude that debt holders have to be prepared to enter an age of financial oppression.
Folks, this is the scariest document you're likely to read for some time. I can't ever recall in my lifetime a major financial firm such as this having such a negative outlook to this extent.
But it’s all true. Simple math dictates this.
I say we abolish all the government programs including social security and medicare and just pay off the poor old folks. Let the states figure it out. Get rid of the IRS and get a new way to fund the military. Let the markets work.
But I have to say that since about Sept 2008 (almost two years now) economic experts have been saying that we are just inches away from a total collapse of the global economy.
I suspect that this is so.
But the current situation is such that a lot of people are walking around with smiles saying that the economy is coming back, although current growth is somewhat slow.
There is a major, major disconnect somewhere here. And that's what scares me the most. Does anyone really know anything about economics? It sometimes appears that everyone is just groping in the dark.
It’s not only how, but “when”. I say sooner rather than later. And it’s going to be really, really ugly when it happens.
You could lay every Economist on the planet end to end and they still wouldn't reach a conclusion.
“Does anyone really know anything about economics?”
Well, the brilliant, really really smart, all-knowing, intellectually advanced, really really bright Democrats know everything about economics; they will tell you so.
They have every confidence that their brilliant, superior, really really smart decisions about the economy will advance everyone into a new utopia. The proof is that they’ve said so.
“Folks, this is the scariest document you’re likely to read for some time. I can’t ever recall in my lifetime a major financial firm such as this having such a negative outlook to this extent.”
I agree that this report is sobering. The article emphasizes financial oppression but ignores currency collapse. Financial oppression will certainly occur but currency collapse seems as the major brake on excessive spending. We have recent examples of currency collapse but only for countries without major economic influence in the world. The rest of the world is very uneasy about the dollar given the excessive current and future spending here along with a decline in our economic output. Although other countries do not want a dollar collapse, I think that currency markets will have other ideas. Unless we reform our excessive spending and economic policies, currency markets will perform the job for us with very ugly results.
Guaranteeing two years of interest does not guarantee payback of the principal.
First to fall will be either Greece or one of the Eastern European Union nations - Hungary or Bulgaria. Greece will fall because its workers refuse to accept that with productivity 30% less than Germany, a retirement age of 62 cannot be supported. They will strike until this government falls, rinse and repeat.
After that, the big domino is the UK. UK has a worse financial situation than Greece. For some reason the British pound has risen the past few months. This is probably due to higher short-term interest rates (vs. lower in the U.S.) and the fact that it isn’t the Euro.
This may drag the European Union down, or the U.S. may fall next. U.S. is in far worse shape than the EU, but if Germany returns to the mark, the euro will fall immediately.
Only because the Japanese have a high savings rate will the yen hold out a few years. But their government is in worse shape financially than Greece or the UK. And somewhere in the process, Chinese equities will plummet in yuan terms, but may hold up in dollar/euro/pound terms.
Best buys in the U.S. are and will be profitable companies with long-term debt. This does not include banks or insurance companies, as money will be pulled by consumers to buy necessities. Investing in grain companies (DE, CAT, Cargill - oops Cargill is privately held, POT) should be good, although ADM has risks if/when corn ethanol subsidies go away.
“For some reason the British pound has risen the past few months”
Could it be that the UK Prime Minister’s austerity program is having a positive impact... he’s cutting programs all over the place. And his poll numbers are going up!
“Guaranteeing two years of interest does not guarantee payback of the principal.”
True but even short term debt (1-2 years) has skyrocketed. it has to do, IMO, with banks not trusting Greece. There’s always that “we don’t want to pay.”
For the rest I agree with you. In crises all niceties go outside the window, everyone thinks for themselves. Greece and other parasites will suffer.
Liberal Globalism never works....because the world eventually runs out of America’s money.
Reality is....that the days of Liberal Globalism are over....the world will go back to protectionism and tariffs...it will be the only way to rebuild national economies. The sooner nations adopt this...the sooner they will be able to rebuild.
Every bailout instituted by governments have been to cover the losses of banks and businesses diue to Liberal Globalism. Keep bailing out, and, the economic failures will worsen
Exactly! NAFTA is to blame for Fannie and Freddie pushing home loans to American deadbeats!
Because the era of Smoot-Hawley was so effective at building/rebuilding national economies?
Free trade was responsible for the Community Reinvestment Act, not corrupt politicians trying to curry favor through wealth redistributionist schemes? Higher prices are beneficial because we can then afford to buy more, thereby raising our standard of living? All that additional revenue flowing to government will be efficiently put to use driving the innovation that will provide the jobs of the future?
The stuff one can learn here.....
What do they practice in Canada? It sure isn’t Liberal Globalism or protectionism.
I don’t see why we bother. Someone could post a thread titled, “Excessive Sun Exposure Causes Alcoholism,” and someone else would parachute onto the thread to blame “free trade.” (Whatever the definition of free trade is that particular day).
All you need to know about economics is this:.......
There is no free lunch.