Edward Chancellor: Public Finance Is A Ponzi Scheme
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Edward Chancellor: Public Finance Is A Ponzi Scheme
TBQ Fri Jul 09, 2010 4:30 am
Submitted by Tyler
GMO's Edward Chancellor has written what is arguably the coup de grace of papers analyzing the dynamics of soveriegn default, together with the conditions required to succumb to this terminal condition, and is the functional equivalent of months of research and combing through all the recent literature on the topic. By initially highlighting the reasons for government default, which include i) a reversal of capital flows, ii) unwise lending, iii) excessive foreign debts, iv) a poor credit history, v) unproductive lending, vi) rollover risk, vii) weak revenues, and viii) rising interest rates, Chancellor presents the frame of reference in which every potential sovereign default situation should be analyzed. Chancellor also highlights several examples where a sovereign default was all but assured (Britain post the Napoleonic wars, Sweden in the 1990s), analyzes the opportunity cost of hyperinflating instead of pursuing default (when inflation is more convenient, when it resolves political conflicts, when avoiding inflation is a low priority, and when there has been a public credit flameout), and makes an exhaustive analysis using historical parallels of today's sovereign debt crisis.
He summarizes the different view of the current sovereign fiasco as follows: i) this time is (really) different, ii) we are not all Greek, iii) posits that the US is not on the verge of a default, iv) that inflation is more likely than default. He concludes by analyzing potential tipping points, which in a herd mentality market such as ours, are all that matters, and suggests that Japan is precisely on the verge of such a tipping point. Yet his two most critical conclusions, in our opinion, are the following: "public finance is a ponzi scheme" and, for all those who are fans of Rosie's thesis that bonds are the go to investment currently, "Current yields on government bonds in most advanced economist are at very low levels. Under only one condition - that the world follows Japan's experience of prolonged deflation - do they offer any chance of a reasonable return. But this is not the only possible future. For other outcomes, long-dated government bonds offer a limited upside with a potentially uncapped downside. As investors, such asymmetric pay-off profiles don't appeal to us." Worthwhile read for everyone who wants to have an intelligent opinion on the matter.
GMO's Edward Chancellor has written what is arguably the coup de grace of papers analyzing the dynamics of soveriegn default, together with the conditions required to succumb to this terminal condition, and is the functional equivalent of months of research and combing through all the recent literature on the topic. By initially highlighting the reasons for government default, which include i) a reversal of capital flows, ii) unwise lending, iii) excessive foreign debts, iv) a poor credit history, v) unproductive lending, vi) rollover risk, vii) weak revenues, and viii) rising interest rates, Chancellor presents the frame of reference in which every potential sovereign default situation should be analyzed. Chancellor also highlights several examples where a sovereign default was all but assured (Britain post the Napoleonic wars, Sweden in the 1990s), analyzes the opportunity cost of hyperinflating instead of pursuing default (when inflation is more convenient, when it resolves political conflicts, when avoiding inflation is a low priority, and when there has been a public credit flameout), and makes an exhaustive analysis using historical parallels of today's sovereign debt crisis.
He summarizes the different view of the current sovereign fiasco as follows: i) this time is (really) different, ii) we are not all Greek, iii) posits that the US is not on the verge of a default, iv) that inflation is more likely than default. He concludes by analyzing potential tipping points, which in a herd mentality market such as ours, are all that matters, and suggests that Japan is precisely on the verge of such a tipping point. Yet his two most critical conclusions, in our opinion, are the following: "public finance is a ponzi scheme" and, for all those who are fans of Rosie's thesis that bonds are the go to investment currently, "Current yields on government bonds in most advanced economist are at very low levels. Under only one condition - that the world follows Japan's experience of prolonged deflation - do they offer any chance of a reasonable return. But this is not the only possible future. For other outcomes, long-dated government bonds offer a limited upside with a potentially uncapped downside. As investors, such asymmetric pay-off profiles don't appeal to us." Worthwhile read for everyone who wants to have an intelligent opinion on the matter.
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