The answer to the eurozone crisis – theft

I had coffee with CLSA’s Russell Napier yesterday. I still think that the odds of Greece leaving the eurozone are very low indeed. Not many people agree at the moment, so it was something of a relief to find that he does. It is all very well being a contrarian but one doesn’t want to be too lonely.

But if the zone doesn’t break up, how does it survive? Napier’s answer has long been financial repression. It would be nice to think that we could all grow our way out of debt, but that probably isn’t an option any more. There isn’t likely to be much growth in the West over the next few years, and there is even a chance that we might have reached a point from which we can’t grow at all for many decades to come (see this week’s magazine for more on this). And even if the likes of Greece could grow, it is hard to see how they could ever grow enough to deal with today’s levels of debt.

So, says Russell, there are now only three ways over-indebted European nations can service their debts. They can borrow the money. They can print the money. And they can steal the money from the private sector. I’ve been tempted to think that the resolution (temporary at least) will come via the second of the three. I also tend to think that the second and the third are more or less the same thing. If a central bank prints new units of money, it makes each existing unit of money worth correspondingly less (anyone in doubt need only check the moves in the sterling exchange rate since our first round of quantitative easing (QE)). That represents a theft of value from anyone holding units of money pre-print.

However, Russell thinks that the electoral bias against endless printing might on this occasional actually prevent it happening in the kinds of volumes required. There’ll be a bit of European Central Bank-led QE he reckons, but not as much as I think. Instead, governments will end up going for national theft solutions.

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So far, only a small section of the private sector has been forced to pay up for the follies of the public – the depositors whose saving are being destroyed by negative real interest rates and those on fixed incomes they can’t force up to meet inflation. But the extension of this theft is likely to mean forcing institutions to buy government debt on previously unimagined scales. In India, the banks have a standard liquidity ratio of 25%, the explicit aim of which is to “augment the investment of the banks in Government securities.” Why not Italian banks too? And why not the pension funds?

If you want to see how all this unfolds you should simply read – or re-read – what appears to be the best road map of the crisis so far, Reinhart and Rogoff’s This Time is Different or the paper Reinhart co-wrote this year titled The Liquidation of Government Debt. As they say “first comes financial crisis; then comes sovereign debt crisis; then comes financial repression.”

Governments encourage credit expansion (it’s great for tax revenues and growth). Bad debt piles up. You get a panic. Governments nationalise the bad debts of the financial sector. They end up with nasty deficits and soaring public debt. It gets harder for them to borrow in the bonds markets. So, desperate, they look for ways to force institutions to hold their bonds, willy nilly.

This is the point at which financial repression begins: banks are forced to hold government bonds, for “liquidity”; pension funds are forced to hold government bonds, for “safety”; interest rate ceilings are imposed on private lending; to prevent “usury.” Finally and “if all else fails, exchange controls are imposed, to ensure nobody can easily escape from such regulations.” All this should steadily push bond yields lower and lower, something that combined with a steady dose of inflation has the effect of gradually eroding the national debt.

I like this. It’s dishonest of course. It’s also unkind to pretty much anyone who has saved or who wants to save. But it is also probably the least painful way of dealing with the hideous overhang of debt from the financial crisis without prompting another major crisis. If you fancy betting on it, there is an obvious way to do so: buy European sovereign debt. And lots of it.

  • Porkydawky

    Agree. Only a matter of time before pensions funds etc. are forced to take on government bonds, and this will be done in the name of “safety”. I.e. protection from risk of volatile markets. Politicos will do anything to remain in power and maintain status quo for as long as possible.

    In the end the Ponzi scheme will collapse, and we shall be robbed blind by devaluation. Only solution, as ever, is to invest in hard assets. I expect Greece to default by end of month, especially if Slovakia keeps telling the TRUTH and not voting for EFSF. They have my support.

    The point most MSM miss, is where does it all end? Do they honestly think that the rest of the PIIGS and Belgium will also not want bailouts?

    Get ready, there is a storm coming.

  • John Stringer

    And for those of us not quite as smart as we should be – why should European sovereign debt benefit from all of this? Because it is priced expecting a default but a default won’t be allowed to happen? Should we be buying Greek debt, Irish debt or German debt? Cheers.

  • Adrianjs

    @ Porkydawky. As a director of a pension fund I can tell you that the govermment cannot force my hand into making any particular investment by the fund. There is an awful lot of rubbish talked about pension funds. Yours is just one mis-informed example.

  • Les

    So many banks in deep trouble over their involvement in soveriegn debt – and the bailouts to save them get ever bigger.

    If memory serves me right Money Week suggested (a good while ago) that the banks’ highly-leveraged involvement in derivatives will generate problems far greater than that caused by their involvement in Bonds.
    So, why has the discussion about the unwinding of Derivatives died down ? Has the problem gone away ?

  • Fraudo Baggins

    There are two things I don’t understand here. How does it help to buy European Sovereign Debt, when it is at very low interest rates already, some holders are being promised a ‘haircut’, they are about to issue a lot more, and we are facing inflation in the medium to long term?

    Furthermore, how does capping private interest rates present a problem. People pay ridiculous interest rates because they are desperate. Some of the ‘payday loans’ operators are above 4000%. That IS usury, and capping it can only be a good thing.

  • Fraudo Baggins

    AdrianJS – if the government oblige you to hold a proportion of your fund in Government Bonds, how are you going to refuse to do it? Do you not need a licence for what you are doing? At least you have the government to blame when the value of your holdings falls.

  • James

    @ Adrianjs. As Winston Churchill said, a thing is right because Parliament voted for it. Therefore as a pension fund director, you should pay close attention to what goes on in Parliament! They’ll vote for it, and you’ll have to do it!

  • newboy

    What is European sovereign debt and how do I buy it and are my ISA’S safe?

  • A soon to be poor european

    The EFSF will issue bonds which the european governments will be obliged to buy and in turn they will issue bonds (or simply print money QE style) to pay for said Euro bond. This way the EFSF will save Europe. Everything will be devalued but Greece will not default, nor fall from the Euro – neither will anyone else, but I feel the Germans (public at any rate) will want to leave. I think they should be told.

  • charlesdb

    Adrianjs: It’s not the Government you want to worry about, but the Pension Regulator. He can force you to do anything he wants, to make sure your pension deficit (if you have one) is covered. And by forcing down interest rates thus increasing Pension deficits, the Govt doesn’t have to force you to do anything, except bow to the Pension Regulators demands.

  • Jon

    …Solvency II, Basel II – stepping stones to the third option ?

    Or how about a more blatant theft – (re)appropriation of pension assets, as enacted in Argentina ? In the UK, those billions of contracted-out rebates paid to pension schemes must look like tasty pickings for a cash-hungry Government, and relatively easy to justify as they were in effect turning the state pension ponzi on it’s head…

  • Jim

    Read John Stepek article “Whatever the outcome of this crisis, the euro will fall further” dated 12/10/11.


    Its a journalist report on what its like in Greece.

    Daunting reading, I was amazed, in an ambivalant way.

  • Arthur

    why does money week hardly ever talk about debt deflation. What the debt is doing is sucking the growth out of the economy, that should stop inflation from happening. Plus if we get defaults and write-ofs we see massive deflation in assets that were once purchased with these debts. If we believe the depression repeats it self then deflation will come on a massive scale.

  • newboy

    Read all the above comments and now realize that neither my ISA’S nor any other part of my wealth is safe from legal theft. So I don’t intend to buy any European sovereign debt but bet it all on a Welsh win in dollars

  • Mike

    Well it won’t be Goldman et al paying for it. Not that anyone could blame them in any way for the Euro malarky (Hmm).

    Isn’t theft a bit of a problem with gold, you wouldn’t have wanted to be holding gold a couple of months ago in West Croydon . Come to think of it, what sort of a bath did the Yanks make holders of gold take in the 1930’s not to mention the German’s position on Jewish holdings of gold in the 1930’s and 40’s.

    When time get really tough probably best not to be seen holding anything of any value.

  • Bowler

    We should all be prepared for ‘theft’. In the 1930’s Rossvelt passed a law forbidding people to hoard or own gold and those caught could get a stiff prison sentence or a heavy fine. Those already holding gold had to sell it back to the government at an agreed price which was about 10% higher than the market price. When thwe US had all the gold they devalued the currency 40%.

    Politically its a winner because only the higher middle class and wealthy own gold and they are few in number, law abiding and obedient.

  • A soon to be poor european

    Dear Jim

    Just read the Vanity Fair article. Begs the question – ‘to what extent are other european countries using greek magic’


  • Dr Ray

    Pension funds were forced to increase their holding of government debt some time ago when Gordon Brown was chancellor. One of the reasons managed pension funds have been so poor. Banks were also forced to increase their reserves over the last few years. Many chose to do this by buying Greek and Irish bonds (Ha Ha Ha). So we are not discussing something which might happen, it is already in place but obviously no situation is so bad that a politician can’t make it worse.
    I do take exception to MSWs assertion that the private sector needs to be robbed to help out the public sector. All the public sector employees who have lost their jobs or are in a wage freeze for the forseeable future to bail out the private sector banks and subsidize the private sector bonus culture wouldn’t see it that way

  • Critic Al Rick

    @ 18. Dr Ray

    The Public Sector needs to differentiate between Truly Private Sector and Virtual Monopolies & Psuedo Cartels (VM & PS); it is these (latter) Bastions of ‘Parasites’ with the exhorbitant bonus cultures, etc.

    The Truly Private Sector is being robbed to subsidise an excessive Public Sector and its unsustainable pension arrangements (where applicable). The Truly Private Sector and a large part of the Public Sector are both being robbed to feed the voracious appetites of the VM & PS ‘Parasites’.

  • Dr Ray

    @ Critic Al Rick

    Agree with almost everything you say. The current divisive rhetoric about the “wealth producing private sector” and the “feather-bedded public sector” overlooks the fact that the private sector employees were forked over over the last 2 decades or so, not by the public sector but by their own bosses Now the public sector is getting the same treatment, with many in the private sector happy to look on, even though the public sector includes many who never benefitted from the money used to buy votes and are among the lowest paid in the UK.
    Was it Caesar who coined the term “divide and rule”?

  • Critic Al Rick

    The maxim ‘divide and rule’ was utilised by Caesar; and it’s, as you quite rightly infer, a political tool in use today.

    Young vs old, saver vs debtor, home owner vs tenant, Tory vs Labour, etc, etc … Public Sector vs Private Sector. All perpetrated and stoked-up to detract the proles from the important issues – the Common Enemies (CE) … the perpetrators of the crisis in the West.

    But it looks as if the proles are beginning to see through the smoke and around the mirrors – demonstrations in 950 cities around the world last Saturday. The seed of the CE is within our elected representatives – the ones who have betrayed us to an ever increasing entourage of ‘Parasites’, particularly the Banksters who now make GEs a virtual waste of effort inasmuch as ‘power to the people’ is concerned.

    To be more on topic: the answer to the crisis of the eurozone (West) is partly to fettle the ‘Parasites’, starting with the richest and working down. Interesting times ahead?

  • Tom Brialey

    Given that senior bank directors pre 2008 did not understand how the derivative markets worked, can we really believe that the European political leaders of today will see a way out of this. I doubt it. Default and the end of the Euro is nigh.

  • Austen Naughten

    “So far, only a small section of the private sector has been forced to pay up for the follies of the public”.

    This complete reversal of recent history is breathtaking in its chutzpah.

    What has actually happened is that the public sector in Europe, UK and the USA has had to find TRILLIONS to bail out the private sector. It was the banks who, having argued for light regulation, bet the farm, then came to the public sector demanding bailouts.

    Sovereign debt is relocated private sector debt.

    The ingratitude is galling!