GMO White Paper Examines Sovereign Debt Crisis

? Under what conditions do governments opt for inflation rather than default?

? In light of historical findings, is Greece really the crest of a wave of sovereign debt crises about to crash down upon the developed world?

Chancellor writes that because of the financial crisis, major sovereign credit markets have "entered the darker province of uncertainty. The future performance of sovereign credits depends on future events and decisions that are unknowable. Among these are whether the global recovery will be sustained, or economic growth and tax revenues languish for a prolonged period. Will central banks engage in more quantitative easing "until they reach a point of no return," or tighten too early?

No one knows the answers to these and other questions, according to Chancellor. "Current yields on government bonds in most advanced economies (PIGS-Portugal, Italy, Greece and Spain- excepted) are at very low levels. Under only one condition–that the world follows Japan's experience of prolonged deflation–do they offer any chance of a reasonable return. But this is not the only possible future. For other outcomes, long-dated government bonds offer a limited upside with a potentially uncapped downside. As investors, such asymmetric pay-off profiles don't appear to us. Caveat (sovereign) creditor!"

Michael S. Fischer ([email protected]) is a New York-based financial writer and editor and a frequent contributor to WealthManagerWeb.com.