In a new note on a global sovereign credit risk, CreditSuisse has the options correct, but the probabilities wrong:
We believe there is a 25% likelihood that we grow our way out of trouble, a 60% likelihood of a ‘muddle-along’ scenario (described above), a 10% likelihood that we enter sustained deflation and a 5% likelihood of a global sovereign default.
I can’t imagine I’m the only one who thinks the muddle-along scenario — more QE plus 4% budget tightening — probability is over-estimated, while the default likelihood is underestimated.
Later in the note, CS helps explain one of the main reasons why, and then ignores itself:
Capital controls no longer exist and most developed countries have independent central
banks. In consequence, it is much harder for a country to ’inflate‘ its way out of its
In 1942, the US Treasury capped the US ten-year bond yield at 2.5% (and the 3m T-bill
rate at 0.38%). Over the following ten years, inflation averaged almost 6% and, as a
consequence, the stock of government debt to GDP fell from 120% to 66% (despite real
GDP growth over that 10-year period being just 2% pa). Any attempt to cap bond yields
today would likely lead to a sell-off by foreign investors (back in the 1940s, the US were
running a trade surplus, i.e. was exporting capital). It is clearly harder to allow a sharp
depreciation of a currency for countries with independent central banks (which have a
mandate to keep inflation low) and which, like the US, run a current account deficit and
thus need to attract $350bn a year of foreign capital.