A few months ago we wrote an article entitled «The Big Writedown« in which we warned of the possibility that the impasse of massive debt in which the whole world is mired could be circumvented in an imaginative way.
This formula is none other than the selective elimination of debt issues that are almost entirely in the hands of the respective central banks.
In this way, the loss that any default entails would be accounted for on the only balance sheets in the world that can be squared by making money out of thin air and moulded like chewing gum, namely the balance sheets of central banks.
If the creditor is not disadvantaged, nobody will be, as the debtor’s balance sheet will improve: it will have less debt and will be slightly more sustainable than before.
If, on top of that, the credit rating agencies turn a blind eye, that is to say, if they pull a euphemism out of their inscrutable sleeve that allows them to maintain a respectable rating following the selective default, the debtor will get off scot-free without leaving anyone in the lurch, as the ECB will plug the hole left by the default with fresh money.
So far, they have not dared to issue debt sovereign ad hoc so that they are purchased in full by central banks, but debt issues have already begun to be placed discreetly corporate European bonds issued exclusively for the ECB, as explained by Gurusblog in «Creating bonds to sell to the ECB«.
Logically, this debt is exchanged at the ECB’s counter for fresh money, which is used to cover maturities on other issues whose creditors are diverse and intolerant of potential credit events. Incidentally, it is also significant that the first two issues created specifically for the ECB are from Spanish companies (Iberdrola and Repsol); after all, major remedies must be applied particularly where the major problems lie.
But the path has already been mapped out and the pilot scheme for corporate issuers is now underway. Perhaps this is the only possible solution for reducing debt, given that diluting it through inflation is proving to be an impossible task in this deflationary environment. The question will be how debtors will react, given that their issues are held by a diverse range of creditors who, once again, will see central banks rewarding the most insolvent debtors whilst punishing those who continue to abide by the accounting rules we were taught as children. And let us not forget that the consequences of ‘bread for today’ – that is, propping up the inefficient with artificial life support – condemn us all to meagre growth and a sick economy in the long term. It goes without saying that, in this scenario, investing in fixed income is a game of Russian roulette that even the most conservative investors should steer clear of.