Download Hyperinflation and state bankruptcies: an acute threat?

8 July 2011
Hyperinflation and state bankruptcies: an acute threat?
Caroline Hilb Paraskevopoulos – Greece, Portugal, Ireland
and even AAA borrower United States: mounting national
debts and the growing fear of defaults are dominating the
financial markets. And the question of whether the debt
burden will unleash galloping double digit inflation rates is
a further worry.
The German economy struggled with very high national
debt in the period after World War I. The debts incurred
by the financing of Germany's war effort were increased
further by war reparations. The German government had
already abolished the gold standard during the war, thus
making way for almost unimpeded growth in the money
supply. At the same time, the economic impact of the war
caused shortages in the goods market. The interplay of
these three factors – uncontrolled money supply growth,
the political acceptance thereof, and excess demand on
the goods market – sowed the seeds of German
hyperinflation from 1914 to 1923.
Is hyperinflation looming ahead?
It is probably due in part to this chapter in German history
that we tend to associate the growth of national debt with
inflation. No wonder, then, that the danger of mounting
inflation has emerged in the current debate. Reducing
national debt by way of inflation carries the risk of
collateral damage, of which the loss of confidence in the
currency is but one example. Consequently, this approach
is regarded as politically unacceptable in industrialized
countries. From the same standpoint, national debt can
only be reduced by inflationary measures if incurred
mainly in the home currency. This is the case in the United
States. It is therefore entirely possible for the federal
government to take a more relaxed attitude to price
developments. But even the US does not want to see a loss
of confidence. In the European Union, this approach
enjoys no political acceptance whatsoever. And so –
despite the debt situation – the ECB has increased interest
rates again in order to nip the inflationary trend in the
bud.
And what will happen when Hellas can no long pay?
Greece has struggled with a debt problem ever since the
nation’s founding in 1830: When Prince Otto of Bavaria
ascended the throne in Athens after 500 years of
oppression under the Ottoman Empire, he faced a land
lacking economic prospects. Already at that time, Greece
financed itself with funds from abroad, which the nation
received only up to 1835.
Even in twenty first century Greece, there is just no way
around debt restructuring. But as history has proven, this
won’t wipe Greece from the map. Many a state – for
example, Germany and Great Britain – has repeatedly
had to authorize a debt default in the course of its history.
Even though the relevant state institutions often remain
intact, the nations themselves are forced to give up any
hopes of independent monetary and economic policy
making. These days, the International Monetary Fund (IMF)
takes over the helm in such cases. It guides states through
the process of restructuring the state budget and helps
them to implement structural reforms. In return, the IMF
offers states loans. Compliance with loan conditions very
often leads to fierce domestic tension. In the wake of such
reforms, people need to tighten their belts for a time in the
hopes of harvesting the fruits of their labors in the form of
structural improvements. Greece exhibits both phenomena
in exemplary fashion.
Inflation low for thirty years. (US inflation rate in %; annual
figures since 1925)
20
15
10
5
0
-5
-10
25
30
35
40
45
50
55
60
65
70
75
80
85
90
95
00
05
10
Source: Bloomberg
What happens in the financial markets?
A state is said to have experienced a "credit event" if it
can no longer service its debt or requests a payment
deferral, or when the maturities of its bonds have to be
extended. The threat of a credit event or of default is often
foreseen on the market, pulling down bond prices by up to
70% for the country concerned. Conversely, this leads to a
sharp increase in yields, which is also a sign that investors
are demanding a higher risk premium for their money. The
domestic currency depreciates sharply as a result. During
the Asian financial crisis, Asian currencies experienced a
devaluation of 30–50% in a single day. In the wake of a
country defaulting, risk aversion increases on the stock
market if the defaulting country is of significance to the
financial market system. Default by the United States, for
example, would knock the financial market system
sideways, while Iceland’s default had no effect whatsoever
Contact: Hyposwiss, Caroline Hilb Paraskevopoulos, tel. 044 214 34 29, e mail: [email protected]
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8 July 2011
on the stock market. The Greek national budget's major
influence on the financial markets is due not so much to
this country's economic significance, but to its membership
of the Eurozone. It is mainly a psychological phenomenon.
Uncertainty is rife because the Eurozone has never had to
solve a problem of this kind – and there's no "divorce
clause".
Overview: The conditions for hyperinflation
Political level:
Political acceptance of inflation
Monetary level:
Uncontrolled printing of money
Lack of political autonomy of the central banks
Real economy:
Shortages in the goods market
Demand overhang
Major consequence of hyperinflation:
Loss of confidence in the value of the currency
Source: internal
Is the threat of hyperinflation and state bankruptcy acute?
Hyperinflation is defined as an inflation rate of 50% per
quarter. We do not anticipate such a development. The
requisite demand pressures on the goods market are
absent, as are political acceptance and monetary laxity.
Though we expect inflation rates of over 2% in Europe and
the United States over the medium term, we regard even a
5% rate as unlikely. A credit event in Greece is virtually
unavoidable in the next few years. The fear of such an
event will certainly trigger repeated nervousness in the
financial markets, but will unhinge neither the system nor
Europe’s single currency: the euro.
Disclaimer: The information contained on this Recommendation List and
specifically the descriptions of individual securities constitute neither an offer to
purchase the securities nor an invitation to engage in any other transactions. All
of the information contained on this Recommendation List has been carefully
selected and obtained from sources that the Investment Center of the St.Galler
Cantonal Bank Group fundamentally believes to be reliable. Opinions or other
representations conveyed on this Recommendation List are subject to change
without notice. No guarantee is assumed as to the accuracy or completeness
of the information.
Contact: Hyposwiss, Caroline Hilb Paraskevopoulos, tel. 044 214 34 29, e mail: [email protected]
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