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.
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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.
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