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Inflation Still the Best Option for Sovereign Debt Crisis – Clem Chambers

US Treasury Secretary Tim Geithner with French President Nicolas Sarkozy on 7th December 2011

The Euro crisis will slowly subside over coming months as the focus shifts to the real problem – that of sovereign debt, predicts Clem Chambers,  author of ‘101 Ways to Pick Stock Market Winners’.

Opinion can get out of sync with reality, especially during periods of crisis. Statements being made now by politicians couldn’t get more hysterical.
Even the International Monetary Fund (IMF) chief can’t be restrained. Christine Lagarde’s outburst about the need to avoid a 1930’s-style depression merely underlines the hysteria surrounding the current economic situation.

A first step back to rationalism is to realise there is not one crisis, but two. The Euro crisis is the one everyone is focusing on. However, this is just a layer on top of the real crisis –  the vast sovereign debt created by deficits, both fiscal and trade.

The Euro crisis has been combined with the developed world’s debt crisis. But both can be dealt with.

The Euro crisis is simple. Germany will not agree to the only voluntary solution – inflation coupled with austerity – without first cementing a federal Europe where profligacy cannot again run unfettered across the Eurozone. Without this federalisation, it will agree that countries in the Euro which are in trouble must work themselves out of it by travelling the long and unbearable road of austerity.

Without inflation oiling the crash landing of Euro economies, the Euro zone will rupture. The choice is thus stark: Eurozone inflation, or the end of the Euro. Fortunately, Europe is ready for a federal future. It cannot face a life of default outside of the Euro and will bow to Germany’s terms. Germany will then go along with 5% inflation and rebalancing will occur over a political cycle or two.

Unless this all but done deal comes unstuck, the Euro crisis is now over.

This leaves the real crisis –  mountains of state debts from London to Washington, from Athens to Bonn.

The UK is already along the road of repair.  It has created a recovery blueprint that Europe and the US are set to follow. In fact, the US has already started along this road. It will accelerate the plan when it is close enough to the Presidential election so as not to interfere with it. Europe can set off as soon as the new treaty is ratified.

“The London Plan” as I call it, is simple.

Over 5 years, create 5-7% yearly inflation by printing money; use ‘austerity’ to scare the public sector into pay restraint; and let the public sector shrink through natural wastage – 2.5-5% a year.

For example, with 6% inflation and 3% natural wastage, in five years the government head count will be cut by 15%. If wages are pinned to zero increase, then ‘real’ wages will have dropped by 25%. Meanwhile, inflation in the private sector will boost tax takes by a third. This is purely nominal rebalancing, but it cuts the real value of government debt by a third, slashes government spending in real terms and balances the budget by inflating income and deflating liabilities and overheads. It’s the classic economic slight of hand, one as old as the Roman Empire and one used across European history up to the 1980s.

It might seem like a shabby con, one that steals from the savers and the elderly and gives to the borrowers and the feckless young, but when a country has spent itself into the ground, the only alternative – sudden default and collapse – is worse.

We can expect 5-10 years of inflation at the 5% level and, with luck, there will not be a sudden vicious burst into the 10-20% zone. However, runaway inflation will remain a possibility as high inflation resets debts that much faster and will therefore be a tempting option for many states.
Cash will thus be the wrong place to invest in. Once more, the spoils will go to those that gamble on taking on debt.

If this conjecture is true, over the coming months the crisis in Europe will slowly subside. Interest rates will be elevated but a level of stability will return. The spotlight will then move to the US.

About Clem Chambers

Clem Chambers
Clem Chambers is the CEO of financial website ADVFN.com and author of “101 Ways To Pick Stock Market Winners".

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