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Hyperinflation As A Debt Repudiation Device? No According To UBS, Yes According To Recently Declassified IMF Paper
Some time ago UBS economist Paul Donovan claimed that hyperinflation as a policy tool to inflate away a staggering debt load (for those of you who have missed all the recent musings by SocGen's Edwards and Grice, this is precisely the situation the developed world countries, not to mention the STUPIDs, find themselves in right now) is unworkable due to the impacts this type of concerted action would have on broader markets. "The idea that governments can readily
inflate their way out of their debt problems is a misnomer — arising,
perhaps, from confusion between the fate of the individual bondholder
and the response of the collective market... [M]odern governments can not rely on markets to remain
collectively indifferent to inflation. Inflation will raise the nominal
cost of borrowing (of course) but through the inflation uncertainty
risk premium it will also add to the real cost of borrowing." Yet a recently declassified paper by the IMF's Guillermo Calvo "Is Inflation Effective for Liquidating Short-Term Nominal Debt?" (a document which was previously not for public use) comes to a frighteningly different conclusion, one which could imply that the last weapon in the Fed's, and the administration's arsenal, could very well be just this heretofore unthinkable "bazooka approach" previously thought only possible in such developing countries as Korea and Venezuela.
The crux of Donovan's thesis focuses on the average duration of a portfolio of government securities, which in a normal world would have a predisposition to longer-dated securities. "The fundamental obstacle to
governments eroding their debt through inflation is the duration of the
government debt portfolio. If all outstanding debt had ten years before
it matured, then governments could inflate their way out of the debt
burden. Inflation would ravage bond holders, and governments (with no
need to roll over existing debt for a decade) could create inflation
with impunity, secure in the knowledge that existing bond holders could
do nothing to punish them." Setting aside for a second the fact that over the past year the government's Treasury holdings have focused on the short-dated side of the curve (with Bills hitting 40% of all marketable debt recently), which would make Donovan's case much harder to prove as it indicates that the Treasury may well be anticipating the need for a (hyper)inflation event, the core issue remains unresolved: when all else fails, the only optionality is precisely inflating. The various administration offices would not think twice if indeed the country, and the private sector, were to reach a point where half or more of their revenue was going to cover just interest expenses - a ratio suicidal for any economic activity (the fact that no banks are lending any money for now is beside the point).
A declassified paper by the IMF, which has recently gained prominence as the last backstop in a Greek bailout, should the EU balk at providing assistance to the country, authored by Guillermo A. Calvo, titled "Is Inflation Effective for Liquidating Short-Term Nominal Debt?" provides a dramatically different perspective than that of the presumably idealistic Donovan. In essence, the paper claims, should a country impose a dramatic surprise devaluation that is big enough "not expected to be followed by further devaluation can reduce the real value of the debt through both inflation and lower nominal interest rates (because no future devaluation is expected)." Ah, the power of the crowd's (flawed) assumptions, so well utilized by the administration currently, which hopes that the consumer class will "expect" things to get back to normal and the old Ponzi regime can resume.
Paradoxically, Calvo's claim is that should there be a preponderance of short-maturity debt, the expectation matrix would be one that makes devaluation less favorable as market actors would expect a devaluation, thereby reducing the impact of any such action. This basically takes Donovan's thesis and puts in practical terms:
Short-maturity nominal debt may not necessarily remove the temptation to devalue in order to lessen the debt-service tax burden. Thus, to the extent that the private sector is aware of the temptation to provoke a surprise devaluation, the temptation will be taken into account by a rise in nominal interest rates. This will increase the fiscal deficit and may actually be a primary force behind a currency devaluation. Therefore, the existence of nominal debt obligations may give rise to a devaluation inflation cycle fueled by expectations.
More observations on the role of expectations:
The mere fact that people expects a devaluation to occur increases the rate of accumulation of government debt, thus giving incentives to devalue in order to get rid of the debt (at least, partially), except possibly in the extreme case discussed at the end of previous paragraph. It is, therefore, conceivable that expectations play a crucial role in the determination of the final devaluation/inflation outcome.
To be sure, debt inflation is not the only outcome. Even the IMF hints at the existence of "more sociall painful types of debt repudiation."
It is important to note that the inflation/devaluation bomb could be largely defused if all debt was indexed to the price level. This type of indexation, incidentally, should not be confused with floating rate nominal debt, since the latter is formally equivalent to the debt instruments that we have been discussing (and which, as shown above, could be partially liquidated through inflation). Price indexation removes by definition all incentives to inflate in order to get rid of the debt (unless, of course, the government plays tricks with the price index). From this point of view, thus, debt indexation to the price level may provide an additional, and maybe even powerful, medicine to fighting the credibility gap. It goes without saying, however, that inflation is just one many debt-liquidation instruments. Hence, removing its tentacles does not ensure that the government will not resort to other, perhaps more socially painful, types of debt repudiation.
Calvo's very troubling conclusion to those who still don't see what the possible endgame for the Fed may be:
The main message coming out of this paper is that inflation may be an effective instrument to get rid of an unduly high level of outstanding public debt. This was shown to be the case even when the monetary authorities are unable to provoke unexpected inflation, and bonds are of instant maturity... A once-and-for-all devaluation will give rise to inflation but will not necessarily lead to an increase in the nominal interest rate. This decoupling of interest rates and inflation restores the debt-liquidation power of the latter.
The bad news of the paper is that short maturities, although a possible reaction to inflationary expectations and imperfect policy credibility (see Spaventa (1987)), are not a sure way to discourage inflation as a debt repudiation device. Therefore, the existence of a relatively large stock of nominal public debt may very well give rise to the suspicion that the government might try to use inflation to reduce the social cost of servicing the debt. Consequently, the public is likely to try to cover itself against partial repudiation by requiring an interest rate larger than under full credibility.
An easy solution to multiple expectations-led equilibria is to index debt instruments to the price level. But for that to really work, all the other mechanisms of debt repudiation must also be disabled. Otherwise, debt indexation, like the removal of a safety valve, may generate even more serious cracks in the system.
Is the IMF paper a harbinger of policy to come? While Donovan is correct in principle, the opportunity cost, should debt levels become insurmountable, of a devaluation will likely be actively considered by all financial "experts" in the administration. Coupled with a prevalent expectation that this kind of action, especially in light of Donovan's analysis, and coupled with a short-maturity focused debt curve, means that the likelihood of just such a policy is becoming increasingly likely.
Full declassified IMF paper link (and Scribd below).
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Seeing as we currently have Debt Ignorance, maybe we won't even need Debt Repudiation.
We ain't ever paying it off as it is, so we'll have to change something.
aw, come on
once obama ze communazi zionist muslim is voted out, a golden new era of fiscal responsibility and real economic growth will ensure the prosperity of the US for many years.
a thousand year reich, if you will
Expectations and tennis. The shorter the portfolio's maturity the faster the surface? Or is it the other way around?
Most points these days will be won on the serve (by the sovereign), and occasionally someone (bond vigilantes) may hit a winner on the return. However, very few rally points anymore. They seem to have gone the way of the legitimate rating agencies.
Like that scene from Waiting for Godot?
They were waiting for a Sovereign Debt rating downgrade for USA? Finally an explanation for the play, thanks!
It would explain the noose all right.
remember? det is gud.
Yes ... det is good doh
Default or Print. No other option. Are you going to tell pensioners their 401K plans are fucked? Show me a politician that will.
"Inflate or die"
Or tell the SS widow that hyperinflation means her entire monthly SS check won't even cover a loaf of bread?
A 'moment of epiphany' quickly races towards paper gold shorts. To all in that group....you deserve it.
God forbid we actually stop mark-to-fantasy on assets and send some rather deserving organizations into bankruptcy, where they belong. Not to mention marking those phony derivatives to zero, where they also belong. Time for some rather thorough audits. I hear Wm. Black has some spare time to devote to this.
I'm sure that the bankster set prefers hyperinflation, just as soon as they can make their well-timed bets to insure their own profits in the turbulent times ahead. Hyperinflation punishes everyone, rather than the specific persons who caused this mess. Arguing about it is pointless since it's too late on the chain of events. We can't get a real solution until we get to the true source of the problem, otherwise we will end up in the same soup again in a few years.
Those pesky "chain of events" causing flight to safety back to US just delaying the inevitable.
Amen to that
Yeah, and C4 is not the accelerant one would use to launch a bottle rocket. Next stupid idea...?
Stuart at 233077, you have hit the nail on the head. Money is a store of value and transferrable to anyone, debt is a store of losses (call it failed expansion plans if you will) in which the only investors are those saving for retirement. Who else would own it? Well, there's the "you have no money to buy my goods, so I will lend it to you to take a larger share of your taxes forever" Japanese and Chinese and the "I have so much money I have no clue what to do with it Middle East", but these are dwarfed by the soon to be pensioners who have assumed that "investing" and "financing" are one and the same. They aren't and central banks haven't grasped this, they never have. The monetary system we operate in assumes that anyone who needs to borrow money automatically pays it back out of profits and expands forever. This is patently false. You can't grow earnings forever and you can only re-arrange deck chairs so many times before this is spotted for what it is. An iceberg event. We know that Medicare/Medicaid require funding to the tune of tens of trillions of dollars, not the odd three or four currently owed to AsiaPEC. These guys have claims of principal and interest equal to the PV of the treasuries they own. That is a problem when the interest/coupons exceed the discretionary component of spending that is funded from taxes. When say 5 trillion of debt owed requires 5% coupons, that is still "only" $250bn a year out of tax revenues of around 2,250 billion dollars in last years budget. (Leave aside the fact that this 10% of taxes reduces discretionary spending of a mere $1,400 billion with a deficit of coincidentally exatly this amount - in other words the only dicretionary spending is what has been borrowed, ergo INSOLVENCY). No, the real risk is that it is not either devaluation, inflation or deflation across the whole economy, it is the requirement to remove the store of value that has moved from "money" to "debt". In other words, anyone who has saved has to be made to be poor, so that those who have borrowed with no ability to provide new or growing cash flow streams can be made accountable. The central banks/governments have existed to redistribute WEALTH. The golden goose has laid a lot of eggs, but it is now barren simply because it has been POLICY to promote failure. It is not a dream worth having. The system is about to create a vacuum for all savings. We need a new system, that stops throwing money at the people who live in the twilight zone of false promises and fat bonuses by gaming the system.
The main message coming out of this paper is that inflation may be an effective instrument to get rid of an unduly high level of outstanding public debt...
What makes him think they want that? Is there any evidence whatsoever to support his assertion that the ptb want to reduce the public debt burden? From where I'm standing it looks like they are trying to increase the burden in every conceivable way.
of course they'll have to print monney for good.
just like they have some master plan
0% interest rate... 400% inflation? maybe 800%... no let bat a 1,000% inflation around... 4%, 8% and of course 10%...
http://inflationdata.com/inflation/Inflation_Rate/HistoricalInflation.aspx?dsInflation_currentPage=1
Lets call it 600% as a high mean.. a middle ground... The real problem... is the squeeze of the secondary markets for non- AAA Rated players.. no one here is so stupid as to not know the truth.. so the banter is a dis-serivce to those less than.
In credit markets, the recent backup in corporate spreads validates our concerns earlier this year that 2009’s remarkable rally in investment-grade bonds had reached fair and in some cases overvalued levels. However, we continue to believe that the current combination of accommodative monetary policy by the U.S. Federal Reserve and strong economic growth in developing market economies will benefit investment portfolios tilted toward risk-based assets in general and stocks, commodities and high-yield bonds in particular. Finally, our forward-looking attention remains keenly focused on the aggregate and regional contours of global economic growth as well as when and to what extent the past two years’ extraordinary stimulus measures will be unwound by their sponsoring governments and central banks.
http://www.northerntrust.com/pws/jsp/display2.jsp?TYPE=interior&XML=pages/nt/0810/1222892049944_989.xml
The summary says that the conclusion comes from analyzing, "a small open economy with perfect capital mobility". It also talks about the model (Fisher model) in use having an exogenous international interest rate. This is not at all applicable to the U.S.
Am I the only idiot who is wondering exactly against whom are we going to devalue? We're not on a fixed exchange rate nor are we on a gold or gold-exchange standard. Devaluing relative to the yuan is relatively meaningless in the grand scheme of things.
Immaterial. Here's why.
Let's say that we increase the money supply by 100%. I haven't had a merit raise for two consecutive years and half a raise for the two years prior.
Yet my expenses are going through the ceiling.
WE, the debt serfs get hurt. We live in a nation ruled by treasonous men and women and I long for the better days of King George and the redcoats.
At least they didn't have a terrorist watch list and the tax burden was reasonable.
" A once-and-for-all devaluation will give rise to inflation but will not necessarily lead to an increase in the nominal interest rate"
Is this guy serious?why with a friend like this,the fed realy doesn't need an enemy. He is forgetting the different countries currency status. For something like this to take place in the US,there is no tellign where the DXY will be. As it is,people are losing faith in the dollar,and who is going to believe a goverment which will say"only this once". And with constant trade deficit,this is the worst thing that a country like the US could do(they probably will do it because it is the worst option,lol).And if they think that a lower dollar is good,because it will encorage exports,look no further that the trade deficit with Japan. While their currency almost doubled between 1985 and now,the trade deficit with Japan stayed the same(sometimes higher,but no lower by much). So,here is a scenario of a possible outcome of a one time inflationary event:A free fall in the DXY to levels unknown and unexpected as all and every forign reserve system will try to be the first to unload. That will be followed by a spike in every imported good. The worst would be a spike by oil to exceed the $140 level it reached in 2008. Results?remeber June and Jul of 2008?because this is where the economy started falling from the cliff,and not when LEH collapsed. It could be even argued that the sharp increase in oil was the catalyst behind all that which followed. Reason?All people who bought homes in far away suberbia have probably done their calculation based on certain price of a gallon(stupid I know,but people nowadays are always one step ahead of the next paycheck),when they were suddenly met with the choice of keeping their jobs,or keeping their house and not paying for the commute. And in any such choice,the job always come first...
That paper is talking, in the open, about how to game us.
DOES THAT PISS ANYONE HERE OFF?
Are we so fucking inured that when we find a smoking goddamn gun, we just breath the shit up our nostrils and go, "Yup, smells like a gun just got fired."
THERE IS NOTHING BUT CONTEMPT EXPRESSED FOR US IN WHAT HAS BEEN POSTED. WE ARE THE ENEMY. AND WE ARE LETTING THEM TOUCH OUR MONEY???? NEVER MIND MANAGE OUR ECONOMY????
It reminds me that I am pissed, yes. However, I have already been through the likely outcomes, my possible responses, made my decisions, and set forth accordingly.
Which has brought me here to this time, place, and ZeroHedge where I find, "Hedging is pointless, mostly." Because on a long enough time frame...
+1
Yorp, everyone just looks around like nothin' happened and goes on thier merry way, compalining about another meaningless data point.
This is the IMF blessing overly expansive monetary policy leading to persistently high levels of inflation as a means of effectively de-leveraging a governmental balance sheet without the politicians accepting responsibility for the problem they've created.
This is the official pronouncement of the exit plan from the global fiscal, monetary and QE stimulus efforts.
Lisren up and listen good, pilgrim. They confirmed your suspicions.
A one time price level increase such as a VAT in the USA; say 9%?
Gee, there's a formula to justify anything and if things don't work out as expected.....
40muleteam borax
Devalue against what ? somebody said...
Devalue against the current value of every other currency and commodity
Race to the bottom
Please explain how you do this in practice, in a world of floating exchange rates, fiat currencies and traded commodities. I'm asking to be educated--how do the authorities in the US actually effect what you are suggesting, through what mechanisms? Please be specific. The hyperinflationist story would be more convincing if people laid out the details through which it would actually occur (instead of just saying the central bank will print).
The paper is referring to a small, open economy with a fixed exchange rate. The devaluation causes inflation through higher prices of tradables, but the nominal rate of interest is not affected due to the nominal rate being a function of devaluation expectations and therefore there is no increase in domestic public debt. In my view, the US is so far from this model as to make it entirely useless.
The obvious answer is a year of Jubilee or complete debt forgiveness. Control inflation the resulting infleation through increasing the resesrve requirements and high interest rates. Since society is unburdened, who cares about high reserve requiements or interest rates? Of course, this will never happen because in this scenario, society benefits and criminal syndicate suffers.
It is called "legal stealing" from those who did things right and actually saved some money....
Now the govt. is forcing these savings to be spent at the top in the bond market....
Tell you what I am going to do....
Stay in cash until a few US Govt. auction failures and monetized auction mishaps.....
In other words I am going to game THEM back....
Somebody tell me that I am am not right in doing so.....
Let's see ....I'll come out of my shell when the REAL GAMES begin....
And as to my choice of words .....well...
Use your imagination....
"Otherwise, debt indexation, like the removal of a safety valve, may generate even more serious cracks in the system."
Quite. Inflate more, cause interest rates to rise with the concomitant need to have to inflate more in order to meet the interest payments, etc etc. At some point it WILL fail, something TPTB haven't yet cottoned on to.
Why is it assumed that we HAVE to have inflation - inflation in the US between 1810 (or thereabouts) to 1900 was effectively ZERO.
http://www.economics-charts.com/cpi/cpi-1800-2005.html
DavidC
No doubt we are approaching a CCC world....
In fact....it already is....if not for the accounting games and money printing....
The fact is Obama is already a lame duck....
NOTHING is going to happen that is difficult to do .....
Which means this....
Monetization and bigger government for the free ice cream lovers.....
And much higher taxes....particularly when VAT happens....
Tell you what.....
Would it not be nice to have some REAL people in office that
cut do the difficult things....
Such as dramatically downsizing government ?
It will happen by default anyway.....because the tax increases will actually make tax revenues plummet....
Guaranteed
Take the above to the BANK....
Got through the paper. The model logic rests on an unanticipated devaluation/inflation burst.
Look at the yield curve. A little too late for unanticipated this time round.
Further, there are two issues crushing the global testicles right now. One is too much debt. Sure inflation would fix this if they could muster some.
The other, closely connected but not exactly the same, is an implosion of leverage, meaning that required collateral is far above what it was a few years ago, and that puts major downward pressure on anything that requires credit. Inflation won't fix this. Inflation won't fix anything here... it will only destroy more collateral.
Any hyperinflation will be no jubilee. The destruction of the world's premier collateral, Treasuries, will destroy the structures that governments have spent big fractions of GDP to sustain.
There is little extant equity in the world. Creditors will take haircuts and debt for equity dilusion. There is no other way.
I think the paper was written from the perspective of a Berlin Wall coming down. As policy, massive money printing wiped out the excess reserve problem of those countries. Think of Poland hyperinflating and Hungary with persistent chronic inflation. Will Ben cross that line?
So my take from this is that the administration is in a standoff with debt holders. If the admin even smells like it might resort to default the interest rate goes much higher and likewise the holders won't move interest rates substantially for fear provoking a government default. Am I wrong about this?
I'm not sure I buy into his argument about the singular repudiation having the consequences he mentions although it is an interesting perspective. I think the ramifications of a default are much less theoretical, especially since it will be very chaotic at that point.
Japan's fiscal crisis- An Anatomy of a Keynesian Failure
The crisis and the stimulus packages of Japan’s government boosted the budget deficit to more than 10% of GDP in 2010. The reduction in the budget deficit – from 8.2% of GDP in 2002 to 3.2% in 2007 has rapidly been reversed, making the target of a primary budget surplus for central and local governments by FY 2011 a sick joke. Gross government debt is projected to rise to 200% of GDP in 2010, and to 100% in net terms. The December 2008 program to upgrade the social welfare system would make fiscal consolidation even more challenging as it implies increasing public social spending from its current level, which is below the OECD average.
2. Japan’s government borrows from Japanese households. But Japanese households are retiring, and traditionally retirees run down their savings. 3. In the past, the Japanese government had a captive domestic market in which to place its debt. A large pool of domestic savers, made cautious by prior painful experience with risk assets and an increasingly fragile economy, was happy to own as much government debt as possible. But those savers are now retiring, and running down their assets. Japan’s demographic decline started in the early 2000s and retirees run down their assets. For the past three years, however, JGB purchasing has levelled off. Of course, household direct purchases of JGBs are a small share of total ownership, as buyers, banks and insurance companies are far more significant. But these corporate buyers are only really recycling the same diminishing pool of Japanese savings. Hence the current trend implies that Japan’s savers will grow less able to continue funding a deficit that is currently running at more than 40% of government expenditure. Source: Japan's fiscal crisisWe are all broke. Nobody has realized it yet.
Hyperinflation As A Debt Repudiation Device?
The guys in the Weimar Republic thought so too.
Ten years later the Nazies were in power and lined them socialistl up against the wall !
Werner
Bravo Dan22, interest rates and ergo bond yields are a thing of the past. There is an emerging mechanism that is surfacing and that is the new rate of THE DRAWDOWN RATE and this will precipatitate a more realistic alignment within capital markets. Rotating (round tripping)credit is over. The drawdown rate says, you made a promise and I want you to perform on that promise at 5% of capital on your outstanding each year. That is the minimum. Just because you are a high quality CCC borrower, does not make you AAA as the ratings agencies would have you believe.
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