Submitted by Gunter Leitold
Will bond investors and savers have to hold forced government loans at some point in the future?
Numerous governments of developed countries are likely to fail when trying to liquidate their large debt burdens in an orderly way. Japan, for example, steadily widened its debt load over the past 22 years and thereby constructed the largest bankruptcy waiting to happen. Since 1990, new borrowings and interest payments were the biggest contributors to build up the Japanese state of pre-insolvency. While Japanese government bond yields have been around 2.6% p.a. on average, these yields were still 2% above nominal GDP growth of just 0.6%.
The chance of not being able to de-leverage is dangerously high when the free market requires a nation to pay interest rates significantly above its nominal growth rate. The nations of the European periphery, Portugal, Spain, Italy and Ireland currently overpay nominal growth rates in the long term bond market by 11,01%, 5.84%, 5.09% and 4.38% respectively. They are directly heading towards the need of a restructuring while Greece has a good chance of requiring a second one.
Nominal interest rates set around 1% – 2% below nominal growth rates for a significant period of time would be needed to help these countries to leave the debt build-up course behind. This change of interest rates would erase mark-to-market losses on sovereign bond positions for the semi-solvent banking sector, but it would also wipe out the carry and leave them without earning power on this part of the balance sheet. However, some of them would still need to restructure. Keeping the high government interest rates in place will lead to some spectacular restructurings in the future.
I assume if central planners decide to circumvent the already manipulated bond market and enforce much lower interest rates by implementing forced loans, there would be a big uproar for some time in the market. However, the negative wealth effect on the private sector would be more foreseeable and stretched out over a longer period of time. This definitely would decrease uncertainty. In my opinion, this measure would actually help to break through the downward spiral and avoid the much more devastating course towards a restructuring event with its negative side effects.
Everyone and their dog realizes that suffering the whole pain of a restructuring event at once is a bad alternative compared to spreading the pain over a longer period of time and spreading it in an orderly and less uncertain way.
It seems that the free market does not provide this option without harsh government intervention. The free market tends towards capital flight, wider risk spreads and thereby makes a restructuring event at the end of the road more likely. Greece for that matter has been half-solved at best and therefore has a good chance of being back on the brink soon.
I believe that at some point, we may see the implementation of a temporary regime which includes forced government loans for domestic private sector participants paired with strict capital controls for as long as the de-leveraging is going on.
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