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How to Become a Trillionaire and Other Thoughts

Saturday, January 7, 2017 16:06
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Careful what you wish for central bankers and fiscal policy makers.  Though we don’t see signs of “rollover risk” in any of the G5 of G20  it’s all about confidence and you know what Joe said about confidence:

Confidence is a very fragile thing.  – Joe Montana

The World Economic Forum reports this about Zimbabwe’s ghost of hyperinflation past,

Zimbabwe was once so gripped by hyperinflation that the central bank could no longer afford paper on which to print practically worthless trillion-dollar notes. 

The government reported in July 2008 that Zimbabwe was experiencing inflation of 231 million percent (231,000,000%). However, the Libertarian think tank, the Cato Institute, believes that the real inflation rate was 89.7 sextillion percent or 89,700,000,000,000,000,000,000%.

It is interesting to note that the country is now grappling with the opposite problem.

Like Britain, Japan, the US and other nations dealing with the consequences of weak demand and cheap oil, Zimbabwe is threatened more by the prospect of falling prices. But that doesn’t mean its people are ready to trust that hyperinflation won’t happen again.

This is what happens when you are not a reserve currency — i.e., there is global demand for and a financial incentive to hold your currency  — and markets have lost confidence in your central bank and central government.   That, in our opinion, is the next major systemic macro swan:  the loss of confidence in a G5 central bank and government.

We still have ongoing debates with our good friends from the modern monetary theory MMT about whether a major sovereign government can default if they have an independent central bank.   Yes, they can!

We had the same debate with our Argentine friends several years ago as to whether their government would or could devalue their currency when it was on an effective currency board.  Yes, they did!  And defaulted to boot.

Just as Russia chose to default on its GKOs (short-term ruble denominated treasury bills) in 1998 with an independent central bank,  the same can happen to a G5 country as we approach the upper bound of debt limits and the lower for longer interest meme seems to be  sunseting in a post-Trump world.

When an indebted sovereign crosses the tipping point — and nobody knows where the tipping point occurs —  where the markets lose confidence in its ability to repay or rollover debt coming due and the window shuts on refinancing ,  they face three choices:

1)  bailout – easy for a small country,  such as Greece,  but Italy or Japan are too big to bail;   2) hyperinflate – print money to pay maturing debt obligations and finance budget deficits.  An aside:  the Bulgarian central bank did this in 1996 resulting in hyperinflation, which peaked at a monthly inflation rate of 242%  in February 1997.   I was in the Bulgarian central bank in the fall of 1996, when a senior official looked me in the eye and said, [Gregor],  we will not let the government default on its treasury securities.”  I knew what was to come;
3)  default and restructure.

Like the Russians,  the decision to hyperinflate, default, or go begging to the IMF, is a political one.  Russia saw that a high percentage of holders of its local currency debt was held by foreigners,  hedge funds such as David Tepper.

Tepper says that losing 29% ($80 million) on Russia when Russia defaulted after an IMF deal “the biggest screw-up in his career”.  – Ivanhoff Capital

The Russians made a political choice to default and inflict the pain on foreigners rather their domestic population through hyperinflation.   What was interesting they continued to pay their dollar denominated bonds, which was a relatively debt service burden relative to the maturing GKOs.  Totally contrary to what MMT predicts will happen.

The major industrialized countries have gotten away with massive money printing and central bank financing not only of their sovereign governments but even some private corporations as well.

Good things don’t last forever.   As interest rates rise and are normalized,  highly indebted countries could enter a vicious cycle on the fiscal side,

Our current debt may be manageable at a time of unprecedentedly low interest rates. But if we let our debt grow, and interest rates normalize, the interest burden alone would choke our budget and squeeze out other essential spending. There would be no room for the infrastructure programs and the defense rebuilding that today have wide support.

It’s not just federal spending that would be squeezed. The projected rise in federal deficits would compete for funds in our capital markets and far outrun the private sector’s capacity to save, to finance industry and home purchases, and to invest abroad.

Instead, we’d be dependent on foreign investors’ acquiring most of our debt — making the government dependent on the “kindness of strangers” who may not be so kind as the I.O.U.s mount up.  – PAUL A. VOLCKER and PETER G. PETERSON

We don’t think foreigners will not be to “kind” to the U.S. in the new hardball world of  Trumplandia.

Furthermore, given the Trump fiscal policy, which will significantly reduce net public savings and dependent on big increases in private investment and consumption for growth, reducing net private savings,  the U.S. current account balance, by definition  will deteriorate markedly over the next several years.   Thus,  their will be Yuuuuge competition for the world’s foreign savings to finance the large U.S. current account deficit.

Remember the National Accounting Identity,

(S-I) + (T-G) = (X-M)

 (S-I) is the ‘private savings balance’ or the difference between private sector savings (S) and investment (I); (T-G) is the ‘government balance’ or the difference between tax receipts (T) and all government expenditure (G); (X-M) is the difference between exports (X) and imports (M) and is usually called the simple ‘current account balance’.  – George Irvin

As the tide on easy money recedes,  we have feeling we’ll be seeing a lot of schlong over the next few years.

Fasten your seat belts, it’s going to be a bumpy night.    Stay tuned, folks.


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