US Treasuries: "Risk free" for How Long?
At least since the end of World War II, sovereign debt risk has been a very real problem, but one confined mostly to the developing world. Sure, there was the risk that the government might decide to inflate away the value of your loan, that risk abated in most places. (Though obviously not all--I'm looking at you, Italy!) Places where it didn't abate were increasingly forced to borrow in other currencies, leaving default as their main option--inflating away domestic denominated debt tended to make your dollar denominated debt problems worse.
Oh, conservatives made noise about sovereign debt risk and inflation, and then they let the liberals take over for a while under the Bush administration, but this remained very much a fringe issue. US government debt is still used as the "risk free" rate, and few governments of industrialized countries have much problem borrowing.
But the financial crisis is making developed-world sovereign debt risk a more worrisome problem. As this article in the New York Times points out, Japan's massive debt is finally starting to become a really worrying problem, especially as they need to borrow more money to stimulate their sodden economy.
Tokyo's new government, which won a landslide victory on an ambitious (and expensive) social agenda, is set to issue a record amount of debt, borrowing more in government bonds than it will receive in tax receipts for the first time since the years after World War II.
"Public sector finances are spinning out of control -- fast," said Carl Weinberg, chief economist at High Frequency Economics in a recent note to clients. "We believe a fiscal crisis is imminent."
One of the lessons of Japan's experience is that a government saddled with debt can quickly run out of room to maneuver.
"Japan will keep on selling more bonds this year and next, but that won't work in three to five years," said Akito Fukunaga, a Tokyo-based fixed-income strategist at Credit Suisse. "If you ask me what Japan can resort to after that, my answer would be 'not very much.' "
How Japan got into such a deep hole, and kept digging, is a tale of reckless spending.
The country poured hundreds of billions of dollars into civil engineering projects in the postwar era, marbling Japan with highways, dams and ports.
The spending initially fueled Japan's rapid postwar growth and kept the Liberal Democratic Party in power for most of the last half-century. But after a spectacular asset and stock market boom collapsed in 1990, the country fell into a long economic malaise.The Democratic Party, which swept to victory in August, promises to rein in public works spending. But the party's generous welfare agenda -- like cash support to families with children and free high schools -- could ultimately enlarge budget deficits.
Japanese officials say that okay, it's not great, but at least they're not as bad as . . . us:
Still, officials insist that Japan is better off than the United States by some measures.
One hugely important difference is that Japan is rich in personal savings and assets, and owes less than 10 percent of its debt to foreigners. By comparison, about 46 percent of America's debt is held overseas by countries such as China and Japan.
Moreover, half of Japan's government bonds are held by the public sector, while government regulations encourage long-term investors like banks, pension funds and insurance companies to buy up the rest.All of this makes a sudden sell-off of government bonds unlikely, officials argue.
Of course, it also means a default will have catastrophic repercussions on their economy and the living standards of their citizens--much worse than a US default would be. But they're right to say that we're not looking so hot either. Ratings agencies have been warning for a while that the US AAA bond rating isn't some sort of divine ordinance, and could change if we don't get our fiscal house in order. Now those warnings are getting a little louder, a little more specific:
The White House has forecast deficits of more than $1 trillion through fiscal 2011.
"The Aaa rating of the U.S. is not guaranteed," said Steven Hess, Moody's lead analyst for the United States said in an interview with Reuters Television. "So if they don't get the deficit down in the next 3-4 years to a sustainable level, then the rating will be in jeopardy."
Meanwhile, of course, a lot of people think that the "automatic" spending cuts which balance the Baucus bill will be rescinded, the way they have been in the past. If that happens, the deficit gets even bigger. And don't get me started on the $300 billion we're going to need to pay for "fixing" Medicare's doctor reimbursements over the next 10 years; as far as I can tell, the current brilliant plan for this is . . . passing it separately so that the new deficits don't get credited to the health care bill.
Yet Obama is still telling everyone that taxes won't rise on the middle class.
I think we've finally hit the wall on deficit spending. There is no more room for tax cuts, or new spending, or anything else government wants to do. Unless the budget picture improves dramatically, there is but one inevitable course, which is whacking great tax hikes to pay, not for any new program, but for the spending we're already doing. Obama's trying to put off that discussion for as long as possible, because once it starts, there isn't going to be much appetite for $100 billion worth of new annual spending, whether or not it's "paid for". All "paying for it" means is that we have to raise other taxes even further.
Bondholders are still going along with our apparently reckless spending plans on the assumption that we'll have to do something, eventually. I'm sure we will. But that "something" is going to be pretty ugly, and almost certainly done at the worst possible time, as Japan's case may end up illustrating. It may even be default, if we don't start acting like adults relatively soon. Sovereign debt risk seems to be back--and the debt is literally bigger than ever.