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If even US Treasuries are now regarded as a credit risk, is there anything left at all in the world of money that can be trusted?
The answer to this question is almost certainly no, but far from being a calamitous conclusion to reach, this might be viewed as a positive development which will in time restore market disciplines to a global monetary system which became based on make believe.
In fact, the idea of the sovereign as a "risk free asset" is a comparatively recent development which has no basis in historical experience. Even in a country such as Britain with no history of default (we'll ignore the case of war loans, which is arguable), government bonds have hardly proved a reliable form of investment.
True enough, coupons have been paid and maturities honoured, but the currency and inflation risks have proved extreme. On any medium to long term view, you would have done much better out of property and equities.
Among members of the eurozone, the concept of the sovereign as a safe haven asset is an even shorter lived phenomenon. The widening of spreads we've seen in the past year and a half of financial crisis is as nothing compared to the way it was before the single currency was launched.
Jeremy Warner
What's left to trust in the world of money?
America's inability to address its fiscal challenges – Sunday night's "bipartisan debt deal" offers only a temporary, sticking plaster solution – has raised afresh an old conundrum.
Relative to GDP, US sovereign debt has been far higher than it is today, but in the past America has been able to rely on fast growth and demilitarisation to return borrowing to tolerable levels. Neither of these things seem likely to come to the rescue this time around. Photo: REUTERS
If even US Treasuries are now regarded as a credit risk, is there anything left at all in the world of money that can be trusted?
The answer to this question is almost certainly no, but far from being a calamitous conclusion to reach, this might be viewed as a positive development which will in time restore market disciplines to a global monetary system which became based on make believe.
In fact, the idea of the sovereign as a "risk free asset" is a comparatively recent development which has no basis in historical experience. Even in a country such as Britain with no history of default (we'll ignore the case of war loans, which is arguable), government bonds have hardly proved a reliable form of investment.
True enough, coupons have been paid and maturities honoured, but the currency and inflation risks have proved extreme. On any medium to long term view, you would have done much better out of property and equities.
Among members of the eurozone, the concept of the sovereign as a safe haven asset is an even shorter lived phenomenon. The widening of spreads we've seen in the past year and a half of financial crisis is as nothing compared to the way it was before the single currency was launched.
Those countries with weak governance were punished for their lack of competitiveness with high interest rates and repeated currency crises. It was a brutal, but reasonably effective form of discipline.
But once the euro had been established, all countries, bad as well as good, came to enjoy the same low interest rates that Germany had earned from years of hair shirted fiscal rectitude. Bond yields converged not because anyone believed the single currency's fiscal rules would make all countries like Germany, but because markets expected that countries which got themselves into difficulties would be bailed out. They have so far been proved entirely correct in this assumption.
Peer group pressure
The abolition of sovereign currencies removed the pressures that markets normally exert on governments to take unpopular, austerity measures. Market disciplines were replaced by peer group pressure from European finance ministers, only a few of whom were in any position to lecture their colleagues on sound financial policies. Once even Germany started to break the rules, the game was up.
All this was brilliantly predicted by Norman Lamont, a former UK Chancellor in the chapter Why I am Against the Single Currency from his book In Office, published nearly twelve years ago.
Increasingly tortuous attempts to prevent wide scale default fail to acknowledge the underlying reality; membership of the single currency has allowed some countries to borrow far in excess of their ability ever to repay.
But it is not all the fault of the euro. Risk compression was a worldwide phenomenon during the boom. In the hunt for yield, investors became oblivious to the dangers. By the end, almost everything was regarded as entirely risk free. Credit rating agencies were corrupted into the process by giving top notch ratings to fundamentally unsafe assets. These judgements then became embedded in regulatory requirements and central bank collateral rules, making everything seem safer than it really was.
Sovereign downgrades
Today, the rating agencies are accused of deepening the debt crisis with repeated sovereign downgrades, but if anything, their pronouncements understate the reality. Their discomfort is nowhere more apparent than with US sovereign debt. Even assuming the latest settlement – which envisages a $2.1trillion (£1.3 trillion) fiscal consolidation over ten years – is ratified, it's not enough to put public debt back on a sustainable trajectory.
It's perfectly true that relative to GDP, US sovereign debt has been far higher than it is today, but in the past America has been able to rely on fast growth and demilitarisation to return borrowing to tolerable levels. Neither of these things seem likely to come to the rescue this time around.
When Standard & Poor's placed the US on negative watch last month, it suggested that a consolidation of perhaps as much as $4 trillion would be required to safeguard the nation's triple A rating.
Heading for a downgrade
Implicitly, then, America is heading for a downgrade regardless of the fact that the immediate threat of default has been removed. Will S&P have the guts to go through with its threat? I'll believe it when I see it. Already S&P has appeared to backtrack in evidence to Congress.
The major rating agencies enjoy an unhealthily cosy relationship with the major sovereigns, and can usually be persuaded to do the "right thing" in the interests of financial stability. As ever, sweeping the issue under the carpet will only make the eventual crisis even worse.
But perhaps oddly, the immediate blow to America if the big agencies do decide to downgrade is likely to be more psychological than real; it may not matter too much for bond yields.
Despite loss of its triple A rating and central government debt in excess of 200pc of GDP, Japan continues to enjoy the lowest sovereign bond yields anywhere in the world.
This apparent paradox is explained by the fact that when there is generalised risk aversion, where consumers are reluctant to spend and companies won't invest, the consequent savings surplus tends to flow into the only place it can – government debt.
Some of the same phenomenon is occurring in the US right now. Much as China threatens to withdraw its support for the US dollar in protest at policies which it thinks debase the currency, it really has no option but to continue buying US Treasuries as long as it maintains such a big trade surplus with the US. The capital surplus is merely the mirror image of the trade surplus.
Dominant reserve currency status in any case gives the US unrivalled access to international borrowing. Dollar hegemony may not last for much longer, but for the time being there are no viable alternatives.
This is both a blessing and a curse for the US – a blessing because it allows the country to keep borrowing at reasonable rates almost regardless of underlying public debt dynamics, and a curse because it maintains the addiction to debt.
If nothing is done, the façade will eventually break; that's the point at which to run for the hills. Food, property, energy – these are the things that retain value when money dies. - Telegraph
But once the euro had been established, all countries, bad as well as good, came to enjoy the same low interest rates that Germany had earned from years of hair shirted fiscal rectitude. Bond yields converged not because anyone believed the single currency's fiscal rules would make all countries like Germany, but because markets expected that countries which got themselves into difficulties would be bailed out. They have so far been proved entirely correct in this assumption.
Peer group pressure
The abolition of sovereign currencies removed the pressures that markets normally exert on governments to take unpopular, austerity measures. Market disciplines were replaced by peer group pressure from European finance ministers, only a few of whom were in any position to lecture their colleagues on sound financial policies. Once even Germany started to break the rules, the game was up.
All this was brilliantly predicted by Norman Lamont, a former UK Chancellor in the chapter Why I am Against the Single Currency from his book In Office, published nearly twelve years ago.
Increasingly tortuous attempts to prevent wide scale default fail to acknowledge the underlying reality; membership of the single currency has allowed some countries to borrow far in excess of their ability ever to repay.
But it is not all the fault of the euro. Risk compression was a worldwide phenomenon during the boom. In the hunt for yield, investors became oblivious to the dangers. By the end, almost everything was regarded as entirely risk free. Credit rating agencies were corrupted into the process by giving top notch ratings to fundamentally unsafe assets. These judgements then became embedded in regulatory requirements and central bank collateral rules, making everything seem safer than it really was.
Sovereign downgrades
Today, the rating agencies are accused of deepening the debt crisis with repeated sovereign downgrades, but if anything, their pronouncements understate the reality. Their discomfort is nowhere more apparent than with US sovereign debt. Even assuming the latest settlement – which envisages a $2.1trillion (£1.3 trillion) fiscal consolidation over ten years – is ratified, it's not enough to put public debt back on a sustainable trajectory.
It's perfectly true that relative to GDP, US sovereign debt has been far higher than it is today, but in the past America has been able to rely on fast growth and demilitarisation to return borrowing to tolerable levels. Neither of these things seem likely to come to the rescue this time around.
When Standard & Poor's placed the US on negative watch last month, it suggested that a consolidation of perhaps as much as $4 trillion would be required to safeguard the nation's triple A rating.
Heading for a downgrade
Implicitly, then, America is heading for a downgrade regardless of the fact that the immediate threat of default has been removed. Will S&P have the guts to go through with its threat? I'll believe it when I see it. Already S&P has appeared to backtrack in evidence to Congress.
The major rating agencies enjoy an unhealthily cosy relationship with the major sovereigns, and can usually be persuaded to do the "right thing" in the interests of financial stability. As ever, sweeping the issue under the carpet will only make the eventual crisis even worse.
But perhaps oddly, the immediate blow to America if the big agencies do decide to downgrade is likely to be more psychological than real; it may not matter too much for bond yields.
Despite loss of its triple A rating and central government debt in excess of 200pc of GDP, Japan continues to enjoy the lowest sovereign bond yields anywhere in the world.
This apparent paradox is explained by the fact that when there is generalised risk aversion, where consumers are reluctant to spend and companies won't invest, the consequent savings surplus tends to flow into the only place it can – government debt.
Some of the same phenomenon is occurring in the US right now. Much as China threatens to withdraw its support for the US dollar in protest at policies which it thinks debase the currency, it really has no option but to continue buying US Treasuries as long as it maintains such a big trade surplus with the US. The capital surplus is merely the mirror image of the trade surplus.
Dominant reserve currency status in any case gives the US unrivalled access to international borrowing. Dollar hegemony may not last for much longer, but for the time being there are no viable alternatives.
This is both a blessing and a curse for the US – a blessing because it allows the country to keep borrowing at reasonable rates almost regardless of underlying public debt dynamics, and a curse because it maintains the addiction to debt.
If nothing is done, the façade will eventually break; that's the point at which to run for the hills. Food, property, energy – these are the things that retain value when money dies. - Telegraph
Govt debts – it’s time to stop fooling around
Plain Speaking - By Yap Leng Kuen
As at press time, an agreement was reached on raising the debt limit; however, the uncertainty created during the stalemate prior to the agreement had cast an element of doubt in the markets over the long term viability of US Treasuries and a possible downgrade of US' credit rating.
The debt ceiling has been raised before; however, the severity of the problems faced by Greece and other countries with high debt levels has caused the US situation to be viewed with concern.
In fact, post-2008 financial crisis, government debt has become a major issue. In a research update, McKinsey Global Institute said while global debt and equity hit new highs, more than a third of growth last year was government debt.
According to McKinsey, the overall amount of global debt grew by US$5 trillion last year, with global debt to gross domestic product (GDP) increasing from 218% in 2000 to 266% in 2010.
Government bonds outstanding rose by US$4 trillion in 2010 while other forms of debt had mixed growth, said McKinsey.
The move to downsize debt needs to be backed up by a concrete and consistent plan that shows not just commitment but also conviction of all parties involved.
Countries with high levels of debt must show that they are not only able to save others but also themselves.
Part of a government's credibility lies in its ability to manage its finances. Simply put, this involves lowering or containing its costs while increasing revenue.
Much effort should be spent on plugging the leakages while taking pains that taxpayers, who usually bear the brunt of others' mistakes, are not disadvantaged.
Postponing the problem by merely raising the limit for another time just makes matters worse; the issue of indebtedness becomes more serious and future governments end up inheriting the problem rather than spending productive hours on new areas of growth.
To get the cooperation of taxpayers to sacrifice for another round of austerity drive will probably not be easy. They may question why they have to pay for the excesses when they had already paid on previous bailouts for the big boys.
It is therefore time to stop “fooling around” with the finances and really get down to work on solid improvements. A transparent approach with proper timelines that can be accessed by all will certainly help.
Once people see something concrete coming up, they will be more convinced and committed towards the common goal.
Moreover, money allocated in a fair and equitable manner will result in better support from taxpayers.
Associate editor Yap Leng Kuen recognises that managing a country is far more complex than a family although the same dose of common sense is required.
