Friday, November 04, 2011

Is it time to reset?

Our economy faces unusual challenges due to the exceptionally high debt burden. In terms of Government debt this is represented through Gilts (Government backed securities of debt). The recommended solutions to our problems usually involved manipulation of the money supply in the hopes that somehow this will correct the underlying problems.

For example, in the UK the Government sells debt with Gilts then, through a wheeze known as Quantitative Easing, it prints money to buy back the Gilts it has sold. The net effect is that GBP is devalued (leading to commodity price inflation), the delta between buy and sell price is absorbed as profits by the counter party (normally a bank) and the entire distribution of wealth becomes further concentrated to the advantage of the counter party.

It would in effect be more cost effective (and honest) if Government's didn't sell and buy back Gilts but simply printed money to counter their shortfall. You'd still however be left with the issue of devaluation.

Now in an export led economy devaluation can help boost exports at the same time as increasing inflation. However, we're not an export led economy, so devaluation without direct investment leads to higher material costs, less profitability in internal markets and correspondingly cost reduction, weakening of the internal market, higher inflation and stagnation i.e. what the media call stagflation.

All of these problems are exacerbated by debt, inequality of wealth distribution etc. In the Eurozone we're seeing this shake out with Greece which faces either a decade or more of misery or default on the Government debt (i.e. gilts)

Now, a Greece default would be a disaster because it would be difficult to raise further debt and investors would be wary of trading with Greece. But wait, it's part of Europe ... the EU could always raise debt for it. I suspect this is why people are so keen for Greece to leave the Euro if it defaults. A country that defaults but then continues is not a message the market wants to hear.


Well despite media opinion, Government shouldn't operate for the benefit of investors but society as a whole and Gilts come with risk (albiet relatively small). Now if a country default and continued to operate, then the problem for the market becomes what if this idea extends? So let us extend this Greek idea a bit more. What if every country in Europe and ideally add in the US as well, simultaneously defaults on Government Debt i.e. Gilts and resets the debt to zero?

Well for investors it would cause one hell of a haircut and some banks would probably fail. However, those can be nationalised where necessary and measures taken to limit the damage. You'd certainly need some form of protective measures for those at the bottom end of society - hence tax raises would be necessary - and Government would need to co-operate to smooth out some of the fall-out.

There'd be lots of nashing of teeth, the markets would suffer turmoil whilst they reset but investment (in the case of shares, gilts etc) is always shorter term gambling and despite the losses the size of the EU & US means investment will still continue, possibly even flourish. It's worth remembering that market indices (FTSE etc) are also not a good indicator of the underlying economy despite the media's fixation on them.

I can't see there are actually any real downsides to a Europe and US default (bar the temporary turmoil etc) except for investors but such gambling inherently occurs risk and these are fairly unique circumstances. The Governments could always shore up the economy by direct Keynesian style investment as well.

Naturally, some would argue that this might collapse the USD / EURO / GBP against other currencies such as the Yuan. But the above approach wouldn't significantly increase money supply (other than investors dumping) and the Yuan isn't a free floating currency. Certainly against other countries they'd be possible devaluation but then given the size of the trading blocks the effect should be minimal over time. What about sanctions? Against Europe & the US - don't make me laugh.

Of course, some will argue it would spook investors so much that there'd be a collapse of investment. However, if the money was invested in Government debt it wasn't invested in longer term infrastructural goals which is what we actually need. Any investors sent to the wall would be quickly replaced by others - that's capitalism for you - and as for pension funds, well it's true that we'd need decent protective measures put in place to protect the poorest but beyond that not a great deal more.

I'm writing this because the UK Government is planning to give more taxpayers' money to the IMF who may contribute to the Eurozone bail-out (something which our Gov. said they wouldn't do) or in other words piling on more debt to help solve problems caused by having too much debt.

This is a cycle we need to break. Can I suggest we reset the market economy by resetting Government debt. A simultaneous default by Europe and US on all Government debt should do the trick.

Does this post mean I believe this is the right course of action? Well, unfortunately whilst the idea is interesting, the practice is virtually impossible. In order to exact such a change, the various Governments would need to agree and execute almost instantly to avoid investors dumping Government bonds on the unsuspecting public (or wrapping them up in some other complex instrument). I have doubts that our leaders are capable of such consolidated action. All it would take is one party to phone a friend and warn them to get out of Government bonds and the entire scheme would unravel quickly.

So, overall ... I agree with the concept but the practice is probably too difficult and it's much more likely that we'll settle for many years (or decades in the case of Greece) of austerity