The U.S. at least has a innermost banker who seems to comprehend the risk.In the face of his connivance in getting us into this mess in the first place, Ben Bernanke has shown he understands the risks that deflation poses, especially in a debt-laden economy,and believes that he has ample tools to thwart deflation from gaining traction in the economy(even with rates at zero).
Generally, we simply can't bring ourselves to own bonds at the yields on offer in most markets today.However,that doesn't mean we are ignoring the short-term risks. So whilst we are generally inclined to be short nominal duration across portfolios (as suggested by the 7-year forecasts),we have been adding nominal duration. How can one add nominal duration when bonds are overpriced?Doesn't this imply that we are betraying our value investing credentials?In early 2009, Christina Romer, Chair of the Council of Economic Advisers, gave a speech laying out six lessons from the Great Depression.
Lesson I: Small fiscal expansion has only small effects. Lesson II: Monetary expansion can help to heal an economy even when interest rates are near zero. Lesson III: Beware of cutting back on stimulus too soon. Lesson IV: Financial recovery and real recovery go together. Lesson V: Worldwide expansionary policy shares the burdens and the benefits of recovery. Lesson VI: The Great Depression did eventually end.
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. 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.However there are good reasons why government bonds should rank senior to most other liabilities.To mention one: governments need to be able to raise finance to fund public investment as well as to perform their macroeconomic stabilization role. They cannot issue equity,and cannot credibly issue secured debt2. Unrestricted access to unsecured, confidence-based funding is core to their 'business model',as it is for banks. This was, historically at least,the main argument for honoring sovereign debt.There are others,not least the consequences of a government default for output and for financial stability when banks own substantial exposure to the sovereign.
