Phorgy Phynance

FT: Moody’s warns on US sovereign rating

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A while back, I was sitting in a meeting with some bankruptcy attorneys that were helping the investment group understand some new bankruptcy laws. After the meeting, I asked one of the attorneys a pretty open-ended question that tends to get surprisingly honest answers:

In the long term, what is your biggest concern for the US economy?

Her answer was immediate and without hesitation:

I can’t see how the US is going to be able to afford healthcare costs for the coming wave of retiring babyboomers.

Not exactly what I was expecting her to say, but the apparent honesty left an impression on me. That is one of the reasons why, when I began voicing my gloomy opinions for the coming credit crisis (even though I’m an optimist!), I said some fairly radical things.

I’ve quoted part of the discussion here when I first learned of the amount of US debt held outside the US.

Looking out over the horizon, say 10 years or more, it was hard to imagine the US being able to pay its obligations. On July 26, Aaron Brown said:

I’ve never understood the argument that foreign ownership of treasuries is a threat to the US. If everyone who didn’t like me lent me money, I’d be happy. I’d be even happier if I got to pay them back with paper I wrote myself. In the 60’s and 70’s, the US sold a lot of debt to foreigners and inflated its way out of repayment. In the 00’s, the US sold a lot of debt to foreigners and devalued its way out of repayment. But people keep lining up to buy more. I don’t see that changing.

I admire Aaron a LOT. He is super knowledgeable AND super helpful. He has uncanny patience and is willing to walk even thick-skulled people like me through technical explanations. What he is suggesting above is that when the US’ obligation become unmanageable, we can simply inflate our way out of it. Sure. That is one solution, but when your obligations are both internal and external, inflating your way out of an obligation to a retired senior citizen doesn’t seem to be the most politically correct thing to do.

What is an alternative?

I suggested that, since much of the US’ obligation is to its retiring senior citizens as well as foreign debtors, one solution would be for the US to default on its external debt *gasp*

Here is my direct quote on July 26:

I’m not sure I’m so enthusiastic about the idea of inflating your way out of foreign debt obligations. That wouldn’t be so great for the domestic economy. Something like what Russia did, i.e. a flat out default, as crazy as it sounds, is seeming like more of a possibility to me though.

The deep and insightful comment from Skillionaire followed:

Eric, I’ve been disagreeing with your views for the past couple of days in this thread, but I believe with this statement you might’ve officially gone off the deep end with this apocalypse stuff you’ve been pushing.

To which I replied:

The good thing about these phorums is that they have time stamps. Sure, today the idea seems crazy. It’ll probably seem crazy for the next 5 years or more. Ten years? Anything is possible. We’ll see. Care to wager on it? Wink

Wager: Within the next 10 years, i.e. before July 26, 2017, a major news source will carry a headline indicating the US may default on a foreign debt obligation.

No one took me up on it 🙂 It’s only been 5 months, but the first cracks in the long term credit quality of US sovereign debt has surfaced

This is from the Financial Times

Moody’s warns on US sovereign rating

The US is at risk of losing its top-notch triple-A credit rating within a decade unless it takes radical action to curb soaring healthcare and social security spending, Moody’s warned on Thursday. The warning over the future of the triple-A rating – granted to US government debt since it was first assessed in 1917 – reflects growing concerns over the country’s ability to retain its financial and economic supremacy. It could also further pressure candidates from both the Republican and Democratic parties to sharpen their focus on healthcare and pensions in the run-up to November’s presidential elections. Most analysts expect future governments to deal with the costs of healthcare and social security and there is no reflection of any long-term concern about US financial health in the value of its debt.

I’ll repeat, I don’t see any real threat of a US sovereign default in the next 5 years, which is probably beyond the horizon of most investors and so might be considered irrelevant. But 10 years? 15 years? 20 years?

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Written by Eric

January 10, 2008 at 10:30 pm

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