Clem Chambers: Investors must keep an eye on the West’s choice of route out of its ever-increasing debts hole

By CLEM CHAMBERS
Published on 15/09/2012 14:16

IF THE West is about to tip over the event horizon of a financial collapse, stocks, at least at first, will do very well. When real inflation is set to run amok, cash will run for safe harbour in anything liquid and in any way tangible. This will mean equities will boom.

The keystone to what is about to happen is in the Maastricht treaty. The debt to GDP limit allowable for entry into the Euro was 60 per cent; 60% of debt to GDP is the absolute ceiling of sensible sovereign debt or at least the limit over which a country wasn’t allowed to join a stable strong currency union on the basis of its debt being too high.

Nothing, of course, has changed as far as economic prudence goes, except none of the big European countries including Germany who signed up for it, are anywhere near under that limit. We can, of course, bemoan the situation, but that’s pointless. The digging of bigger sovereign burdens is going to go on for a time yet. The debt hole is only going to grow.

So let us imagine the end result to be a net 100 per cent debt to GDP for Europe by the time the EU gets it finances in order. Let’s be hopeful it is that low.

Then what? Well if the Maastricht treaties debt GDP ratio was valid, 60 per cent is the target to get Europe back in economic shape.

Imagine that the EU economy, or for that matter the UK or US, can grow each year and keep its costs flat. That’s called austerity.

Let’s say these governments can hold everything in line, inflation, costs etc, and push all growth to the bottom line to pay down the debt/GDP to 60 per cent.

At 3 per cent that takes 12 years; at a more conservative 2 per cent it takes 17 years and even with an amazing burst of dangerous 5 per cent growth, it still takes an achingly long seven years. So austerity and good sensible housekeeping clears the mess in ten to 20 years.

Conclusion: That’s not a good solution.

All real growth strategies are locked into this mathematics. The answer is: it won’t happen this way.

Remember, 60 per cent debt to GDP is the target. How do we get there?

How about giving everyone a yearly pay rise of 5 per cent and having 15 per cent inflation. As long as you can keep the wheels on your democracy the country is back under debt to GDP in three and a half years. In fact, anyone of retirement age will probably remember a situation just like that in the 1970s.

It wouldn’t be nice, or right or fair, but it would be quick and it would be easy. No one has another solution apart from a decade or more of grim, moral, economic depression.

So what do you think is the likely road to be taken by a system quite happy to bury us in debt for a generation?

Ever-increasing deficits and debts cannot go on rolling up forever and the bigger the debt hole there is to fill the more likely the route out of purgatory will be through hell.

There are two roads ahead, the long, hard road and the rupture of an easy way out.

The investor needs to keep a beady eye out for the economies of the West pulling the eject handle.

Because like this crisis we are already five years into, it won’t 
happen overnight.

As long as you understand the elements of the story as it plays out, you will have time enough to adjust to dramatic increases in inflation.

• Clem Chambers is chief executive of stocks and shares website ADVFN