The Greeks have a lot to answer for. Besides roiling the markets and torpedoing the euro, they have inflicted serious damage on the debate about the global crisis and its remedies. Sovereign debt crises used to happen in what was once called the Third World. The tequila crisis, the Asian contagion—the very names made them seem exotic and remote. Now after the Greek meltdown, a sangria crisis, a Chianti crisis, even a Bud six-pack crisis have a horrible plausibility.
If debt is the problem, then surely the solution is to borrow less, not more. That view is in the ascendancy among commentators, politicians anxious to avert financial disaster on their watch, and ordinary citizens rattled by what the future holds. And not without cause. Government debt in the West has soared to levels that would have been considered outrageous until recently. Strangely, though, there is one constituency that seems totally relaxed: the bond market itself. Government bonds have been remarkably strong this summer. Ten-year yields have dropped below 3 percent—not just in sober-minded countries like Germany and Sweden, but also in the spendthrift U.K. and U.S.
What’s going on? The vigilantes of the bond market are supposed to keep free-spending politicians in line. Now the more government IOUs that hit the market, the more love they get from investors. What is happening is this: across the developed world, traumatized consumers are spending less and saving more; cautious companies are earning more and investing less; nobody is borrowing. The result is a tsunami of private-sector money heading for the obvious safety-first destination: government bonds. Government finances may be disastrously out of whack by previous standards, but in our crisis-shocked world those standards no longer apply.
As for sustainability, look at Japan. Yields on Japanese government bonds fell below 3 percent in 1996. A bubble? Many smart people thought so, but two years later Japan slid into deflation, which makes the real price-adjusted returns attractive even if the nominal yields look low. With the government debt-to-GDP ratio north of 100 percent, Japanese bonds currently yield less than 1 percent. Investors are happy just to get their money back, which has been far from the case with stocks and real estate.
The reality is that Greece was always a special case. It is a country that does not issue its own currency, and the quality of its credit depends on other Europeans’ indulgence, now in short supply. The only way it can restore lost competitiveness is by exiting the euro or inflicting a savage squeeze on its own citizens. Neither looks likely. Double-digit bond yields reflect the real possibility of a “can’t pay, won’t pay” denouement. Elsewhere, though, the deflationary undertow that took down Japan is gathering strength. It would probably take only one more recession to tip the U.S. into outright deflation, too. We haven’t gotten there yet and maybe we can change course in time, but the message of the markets is clear. Following Japan down its economic path is a much bigger risk than following Greece.
Would the Japan scenario be so terrible? After all, hasn’t Japan survived its lost decades in reasonable shape? Outwardly that may seem so, but Japan has paid a high price. Twenty years after 1989, Japanese GDP is relatively lower than U.S. GDP was 20 years after 1929. Inevitably, the loss of geopolitical status has been significant, impairing Japan’s ability to tackle China’s strategic challenge. The Japan that was No. 1—celebrated for its unstoppable industrial strategy, super-aggressive corporate managers, and high-rolling consumers—has faded from memory. Less obvious is the psychological deflation—the loss of self-confidence and faith in the future that has made government bonds with yields at vanishing point the only game in town. Inequality is on the rise. Since the start of the century, the number of Japanese households earning less than 3 million yen has risen by 50 percent. Tough times are highlighted by the bizarre stories that emerged recently of people claiming benefits on behalf of pensioners who had been dead for years—including one who was found mummified in the back room of the family home with newspapers from the 1970s.
Deflation is like quicksand. It’s easy to slide into, but devilishly hard to pull free from. The best course of action is to stay well away from it in the first place. That means ignoring Greece, and using every possible tool—monetary and fiscal and regulatory—to avoid its own slow-motion, strength-sapping sake crisis.
Tasker is a founding partner of Arcus Investments.