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Sovereign Debt Is the Next Big Worry
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By MICHAEL CASEY
NEW YORK -- If you're looking for one global risk to really
worry about, look no further than the mountain of debt
accumulated by governments in their efforts to support
domestic economies.
Moody's Investors Service says there's $49.5 trillion of
sovereign debt outstanding -- and this week, ratings firms,
and some jumpy bond traders, have shone a glaring light on it.
The raters are worried that governments' massive deficit-
spending campaigns to pull their economies out of last year's
crisis won't produce enough economic growth to pay for itself.
But none of this is new. A month ago, the International
Monetary Fund projected that the average debt-to-gross
domestic product ratio of the 10 advanced country members of
the Group of 20 developing and developed nations would
mushroom to 118% by 2014. Such numbers have led some pundits
to warn of a debt crisis, especially regarding the U.S.'s
dependence on foreign creditors.
What's key now is that the recent market jitters could be
self-fulfilling. Falling bond prices mean higher yields, which
makes it harder for governments to refinance future
obligations. That will hurt the currencies of those nations
and will challenge fixed exchange rate regimes -- especially
in the euro zone and for currencies pegged to the dollar.
Spain became the latest flashpoint Wednesday when Standard
Poor's changed the outlook on its AA+ rating to negative. As
it did when it downgraded Portugal's outlook Monday, S&P
emphasized a weak growth outlook.
And with their bonds hammered for different reasons, Greece
and Dubai's and Abu Dhabi's government-controlled entities
have similarly seen ratings or outlook downgrades this week.
Also on Tuesday, Moody's acknowledged two elephants in the
room. Although it referred to worst-case scenarios, the agency
said the U.S. and the U.K.-- whose public debt runs to $12.1
trillion and $1.3 trillion, respectively--could potentially
lose their triple-A ratings.
Meanwhile, analysts are worried about Japan, where deflation
makes it ever-more expensive for the government to repay a
debt that's projected to hit 220% of GDP in 2014.
Sovereign borrowers aren't supposed to default, at least not
on local-currency debt, because their central banks can always
print money. But Russia's ruble default in 1998 blew that
theory away. And in any case, printing money to pay down the
debt means robbing Peter to pay Paul: too often, we pay for it
with inflation.
In theory, if a global capacity glut were to continue
generating deflationary pressures, it might not be a problem
to repay the debt with yet more "quantitative easing." But
with so much liquidity already making inflation hawks nervous
and fueling potential asset bubbles, pressures are rising for
monetary tightening, not loosening.
And that's why sovereign strugglers are most at risk. When the
European Central Bank hikes rates it's going to make Greece's
interest obligations only more burdensome.
That raises questions about the entire euro zone. The ECB must
pursue a policy that fits the price stability outlook for the
16-member euro zone as a whole.
But can debt-laden Greece handle that? Or Spain? Or Italy?
What if a U.S. recovery pushes the Federal Reserve closer to
an exit from its extraordinarily accommodative policy stance?
That would hurt big sovereign debtors whose currencies are
pegged to the dollar -- ike Dubai and Abu Dhabi.
Alternatively, what if the biggest shoe were to drop? Although
it's near impossible to imagine the U.S. Treasury formally
defaulting, many worry that its mammoth debt burden could lead
to a dollar collapse. Then all bets are off.
None of these scenarios must play out. Nonetheless, they show
why sovereign debt is the problem to watch. |
