There are growing concerns about a looming credit crisis, triggered by some of the more peripheral countries: Greece, Brazil, Malaysia. Of course it may happen, but it is not necessarily likely. It is true that sovereign debt default has great repercussions, as we have seen since the Latin American debt crisis of the 1980s. But that is not what caused the GFC. What caused the GFC was the mountain of derivatives sitting like a toxic waste dump atop the global financial system.
That toxic waste dump is still there, with over $700 trillion of derivatives leading to extreme uncertainty. And if something goes wrong in the "real" global economy, it can cause the waste to collapse on everyone. But it is not really certain if that trigger will be a collapse of sovereign debt, if that should happen. It all depends on what that would mean for confidence in the system, especially between banks, which is what led to the GFC.
One might also say that prior to the GFC, everyone was talking about the 'Goldilocks economy.' They were very wrong. It just shows that what happens in teh markets is usually very unexpected. So when everyone expects something to go wrong, one has to be sceptical.
And for SMSF investors the lesson is the same as usual: don't over-react by chasing the market.
Ann Pettifor of Prime Economics, who foreshadowed the credit crunch in her 2003 book The Coming First World Debt Crisis, says: “We’re going to have another financial crisis. Brazil’s already in great trouble with the strength of the dollar; I dread to think what’s happening in South Africa; then there’s Malaysia. We’re back to where we were, and that for me is really frightening.”
Since the aftershocks of the global financial crisis of 2008 died away, the world’s policymakers have spent countless hours rewriting the banking rulebook and rethinking monetary policy. But next to nothing has been done about the question of what to do about countries that can’t repay their debts, or how to stop them getting into trouble in the first place.
Developing countries are using the UN to demand a change in the way sovereign defaults are dealt with. Led by Bolivian ambassador to the UN Sacha Sergio Llorenti, they are calling for a bankruptcy process akin to the Chapter 11 procedure for companies to be applied to governments.
Unctad, the UN’s Geneva-based trade and investment arm, has been working for several years to draw up a “roadmap” for sovereign debt resolution. It recommends a series of principles, including a moratorium on repayments while a solution is negotiated; the imposition of currency controls to prevent capital fleeing the troubled country; and continued lending by the IMF to prevent the kind of existential financial threat that roils world markets and causes severe economic hardship.
If a new set of rules could be established, Unctad believes, “they should help prevent financial meltdown in countries facing difficulties servicing their external obligations, which often results in a loss of market confidence, currency collapse and drastic interest rates hikes, inflicting serious damage on public and private balance sheets and leading to large losses in output and employment and a sharp increase in poverty”.
It calls for a once-and-for-all write-off, instead of the piecemeal Greek-style approach involving harsh terms and conditions that knock the economy off course and can ultimately make the debt even harder to repay. The threat of a genuine default of this kind could also help to constrain reckless lending by the private sector in the first place.