PREPARE FOR THE AGE OF “FINANCIAL OPPRESSION”

There’s a colorful report going around this week out of Morgan Stanley that describes the global magnitude of the sovereign debt crisis and essentially concludes that haircuts are coming for bondholders.  In other words, sovereign defaults are inevitable. They say this debt crisis is far from over:

“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’.”

They expand on the argument by showing that debt/GDP can be misleading and that debt/revenue is a more accurate reflection of the current environments:

From this metric the United States is in far worse shape than any other country listed.  The USA is even worse off than Greece.  Unfortunately, there is no mention of monetary systems in the report and the analyst clearly ignores the fact that the EMU is a vastly different monetary system than that in the USA.  I strongly disagree that the sovereign debt crisis is a global issue.  It is primarily a European problem caused in large part by their flawed currency system.  There is no default risk in the USA as I have explained before.  What the United States suffers from is a massive private sector debt bubble that requires substantial de-leveraging.  Where I agree with Morgan Stanley is that this crisis is far from over and that there should and will be haircuts (if only we’d allowed a few more haircuts here in the US banking system):

“It is not whether to default, but how, and vis-à-vis whom. What this means is that – as indicated above – governments will impose a loss on some of their stakeholders and have in  fact started to do so (across Europe at least). 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. “

Source: MS