Morgan Stanley: Governments WILL Default

This is probably one of the most eye-popping research papers presented by the global bank elite – at least this year. After about a year of babbling on about green shoots and a economic recovery, seen by few, hidden in complicated statistics, Morgan Stanley analysts have finally reached the conclusion that’s been obvious to so many; you can’t fix a debt problem by issuing more debt. Adding that the sovereign debt crisis is not just European – it is global, and it is not over.

“Ask not whether governments will default, but how.”

Morgan Stanley

“It is overly optimistic to assume that this can continue forever. The conflict that opposes bond holders to other government stakeholders is more intense than ever, and their interests are no longer sufficiently well aligned with those of influential political constituencies. Investors should be prepared to face financial oppression, a credible threat against which current yields provide little protection.”

There’s really not much to say, other than wow!

Here are some of the highlights:

* “This is the first issue of Sovereign Subjects, a new Morgan Stanley publication focusing on sovereign risk in advanced economies. In this first installment, we take a broad perspective on government balance sheets and raise several themes to which we will return in more depth in subsequent issues. We encourage clients to provide us with feedback on this new publication.”

* “Debt/GDP ratios are too backward-looking and considerably underestimate the fiscal challenge faced by advanced economies’ governments. On the basis of current policies, most governments are deep in negative equity.”

* “This means governments will impose a loss on some of their stakeholders, in our view. 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.”

* “So far during the Great Recession, sovereign (and bank) senior unsecured bond holders have been the only constituency fully protected from partaking in this loss.”

* “It is overly optimistic to assume that this can continue forever. The conflict that opposes bond holders to other government stakeholders is more intense than ever, and their interests are no longer sufficiently well aligned with those of influential political constituencies.”

* “There exists an alternative to outright default. ‘Financial oppression’ (imposing on creditors real rates of return that are either negative or artificially low) has been used repeatedly in history in similar circumstances.”

* “Investors should be prepared to face financial oppression, a credible threat against which current yields provide little protection.”

But there’s more, much more…

Governments Will Default

“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’.”

“Debt/GDP has been higher before, so why worry? As government debt and deficits have swollen to levels for which there exist few recent references, all eyes have turned to a more distant past in the hope of finding some guidance as to what future awaits bondholders. At first glance, history appears to be reassuring, though that is deceptive, in our view. Several advanced countries have experienced debt/GDP levels well in excess of current ones. The US emerged from Word War II with a public debt/GDP ratio of approximately 110%, and the UK with a ratio of 250%. The UK national debt has averaged almost 100% of GDP since its creation in 1693 (see Exhibit 1). Yet the UK government never defaulted through that period. France’s public debt stood at about 280% of GDP at the end of World War II. It did not default either. As a matter of fact France defaulted only once – in 1797 – since the creation of its own national debt in 1789. This is remarkable, considering the number of political, military and economic crises the country went through. So why worry now?”

Well, according to Morgan Stanley, there are four reasons to be worried:

“The problem with these historical comparisons is not the reference: how governments dealt with their war debt burdens sheds useful light on what might be in store for coming years. Rather, the problem lies with the measurement tool: debt/GDP is the most widely used debt metric, but we believe that it is a very inadequate indicator of government solvency.”

This is the four reasons why Morgan Stanley it will end in national defaults:


1. Gross versus net debt. (Statistics lies.)

2. Missing liabilities. (Governments don’t have the assets they need to cover their debt, and who says they have to?)

3. It is not GDP but government revenues that matter. (Unemployment and number of bankruptcies still rising.)

4. Debt/GDP looks at the past. The main problem is in the future. (And no politician plans further ahead then the next election.)

Here you go – a copy of “Ask Not Whether Governments Will Default, but How” by Morgan Stanley analyst Arnaud Marès.

(h/t: ZeroHedge)


Related by the Econotwist:

Michael Milken Warns Against Sovereign Debt

New Testimony From Taleb

Saxo Bank’s “Outrageous Predictions 2010″

The Arab World – Downgraded

Reason To Worry

G7-Countries In Deep Trouble

Sovereign Debt – Just Take The Punch?

Fitch Expects More European Sovereign Downgrades

“Greece Will Default”

Lies, Damned Lies And Statistics

E.U. Parliament To Investigate Euro Zone Bailout

Spain Loses AAA Rating – Here’s The Full Report

European Banks: “Lehman Times Ten”

Global Economy On Fast Track To Disaster

Europe’s Bailout: From Bad To Worse

The EU Stress Test: Working The Media

Wolfgang Münchau: A Cynically Calibrated Test To Fix The Result

Ireland Downgraded By Moody’s

EU Member States Disagree On Debt Figures

Housing Bubbles In Australia, Canada, Norway, Sweden Worse Than In USA

Meredith Whitney: Even More Bearish On Housing And Financials

You Sue Me, I Sue You, Oh Peggy, Peggy Sue

Goodbye Keynes – Hello Ricardo!


Nazi Germany utilized every available resource to fight the Second World War, and one significant weapon in Hitler's economic arsenal was gold - gold looted from the central banks of those European countries which were occupied by the Nazi regime between 1939 and 1942. Calculated at pre-1939 prices, the Germans gained access to about $625 million (US) in monetary gold, only about half of which was recovered by American Forces in April 1945 from a mine in central Germany. The 'Gold War' did not end then, however; it just assumed a different shape. Instead of fuelling Hitler's war effort, the recovered gold soon became a pawn in the Cold War struggle between the United States and the Soviet Union and has remained a controversial issue in international politics for years, one not completely resolved to this day.Although this is an important aspect of the Second World War and its aftermath, it has been largely neglected in historical research because of the lack of adequate source materials. The author succeeded in gaining access to hitherto unavailable but crucial records from archives in West Germany, Britain and the United States and is thus in a position to piece together, for the first time, the story of the Nazi gold loot and the long, complicated restitution of part of this gold by the Western Allies. Hitler's Gold represents an essential contribution to the economic history of the Second World War.

Available at Barnes &

Comments Off on Morgan Stanley: Governments WILL Default

Filed under International Econnomic Politics, National Economic Politics

Comments are closed.