x Abu Dhabi, UAEThursday 27 July 2017

Writing the next chapter on global debt restructing

Investors tend to focus on the little things and ignore the big things, and you can't blame them.

Investors tend to focus on the little things and ignore the big things, and you can't blame them. Little things happen more frequently, and it tends to be easier to predict them and gauge their effect. The big things, though, are likely to have the greatest long-term impact, even if we have trouble seeing them coming. One strategist who likes to ponder the big things is keeping his eye out for signs of a development that few of his peers are contemplating. If it comes to pass, it could create upheaval in global economies and financial markets, and the UAE could play a pivotal role in bringing it about and then in resolving it.

Komal Sri-Kumar, chief global strategist at TCW Group, part of the French bank Societe Generale, believes that something close to a global bankruptcy reorganisation may occur in the not-too-distant future. It sounds pretty drastic and, well, it is. Such a "Chapter 11 process for the world", as he puts it, would provoke extreme movements in the prices of certain assets. Ultimately, though, it could prove a boon for economic growth, and for financial markets, too.

To understand why he thinks such a development might occur, just read the headlines. Late last year it was reported that Dubai was in trouble with creditors and needed fresh assistance from its neighbour Abu Dhabi to see its way clear, at least for the time being. The latest trouble spot is Greece, where the government's longstanding fiscal profligacy, exacerbated by the global recession, has sent its finances to the brink, possibly requiring a European Union bailout.

Who's next? Take your pick. Ireland, Spain, Portugal, maybe even Italy and Britain, are all believed to be poised at the abyss, or at least a stone's throw from it. Paradoxical as it may seem, a resolution in Europe, individually or severally, may have become more difficult, Mr Sri-Kumar said, because creditors of troubled government-controlled entities in Dubai were repaid in full. That makes creditors in Europe less likely to accept a haircut.

It also may sow the seeds for the next crop of debt crises. "If other issues come up, are they going to write a blank cheque and pay full face value?" he wondered. Banks "will make risky loans in the future if there is the possibility of getting paid 100 cents on the dollar. Everyone's playing poker here". Cash-strapped governments have a way to continue paying face value. Call it the Latin American solution: They can print as much money as they need to meet their obligations, albeit at a cost of higher inflation.

They can also keep employing the beggar-thy-neighbour strategy - getting a bailout from a country or region that is financially healthier and has a stake in their stability. Mr Sri-Kumar thinks a better solution is to have a body that fills the role of bankruptcy judge with the authority to decide what proportion of outstanding sovereign debt each nation should pay. "There has to be a global solution where a global entity comes forth and decides how this deleveraging process is going to be handled," he said.

Apart from the massive scale, Mr Sri-Kumar explained, the process will be much like a corporate or personal bankruptcy, and it would have a similar effect. "When someone has borrowed too much," he said, "the creditors get screwed to some extent, then there's a clean slate and you get on with life." It would be a more prosperous life to get on with, in his view, because it would mark the beginning of a new economic epoch and kick-start growth.

His proposal seems to make economic sense. By wiping debt off the balance sheets of weaker nations, it would not ignite inflation or encourage a fresh round of the risky behaviour that got us into this mess in the first place. Whether it makes political sense is another story. Here's the part that could be a deal-breaker for much of the world: Mr Sri-Kumar envisions rich nations taking assets in some debtor nations in lieu of money owed them.

It's hard to believe that such a plan would go over well with voters in the biggest debtor nation, the United States; imagine President Obama handing General Motors over to the Chinese Politburo. But Mr Sri-Kumar contends that a global debt restructuring might catch on if there were a trial run in a particular corner of the globe: the UAE. In my next column, I'll look at how the UAE might serve as the crucible for a global debt workout, and what considerable investment implications might emerge in the country, the region and the world if the plan were implemented.

Conrad de Aenlle writes from Los Angeles about investment and personal finance issues. His blog on contrarian investing for MoneyWatch.com, "Against the Grain", can be found at http://bit.ly/NjaBa