Sovereign risk doesn’t usually dominate the headlines on any given day, but in the wake of last year’s financial cataclysm there’s a sharper focus on the fallout that flows from governments that mismanage their debt and economy.
The elephant in the room, of course, is the U.S. The discussion of America’s fiscal condition has heated up in recent history for obvious reasons, starting with ballooning debt. As the overseer of the world’s reserve currency, which happens to reside in the world’s largest economy, the U.S. enjoys certain advantages that other nations can only dream of. That includes the ability to harbor mountains of red ink.
But as we learned last year, chickens have a habit of coming home to roost. That doesn’t mean the rebalancing of excesses arrives suddenly. And there’s no law says that rebalancing can’t unfold gradually. Indeed, much of what’s unfolded over the past 12-18 months is a rebalancing in the global economy. And the rebalancing continues. Perfect equilibrium is elusive, but market forces are continually pushing economies toward that target, although various frictions can and do intervene. Timing, in short, is always an open question. Nonetheless, strategic-minded investors shouldn’t ignore the risks that arise from the shifting tectonic plates of global imbalances.
Perspective is a valuable thing, though not necessarily as a tool for day trading. But even short-term players assume undue risk by ignoring history. As an antidote, spend a little time with the recently published This Time is Different: Eight Centuries of Financial Folly, which excels in reviewing the capacity for cyclical persistence in the troubles that afflict markets and economies through time. “This time may seem different, but all too often a deeper look shows it is not,” the authors advise. “Encouragingly, history does point to warning signs that policy makers can look at to assess risk—if only they do not become too drunk with their credit bubble-fueled success and say, as their predecessors have for centuries, ‘This time is different.'”
Having just lived through one of these episodes, it’s tempting to think that we may not see another for years, perhaps a generation or two. But some are now talking of the extreme low rates of interest as fueling yet another period of excess. Perhaps, although intentional reflation is the tactic du jour. In any case, a bit of perspective never hurts. With that in mind, here are a few worthwhile views on related matters from around the web:
NY Times (Nov. 22, 2009)
Excerpt: “With the national debt now topping $12 trillion, the White House estimates that the government’s tab for servicing the debt will exceed $700 billion a year in 2019, up from $202 billion this year, even if annual budget deficits shrink drastically…Americans now have to climb out of two deep holes: as debt-loaded consumers, whose personal wealth sank along with housing and stock prices; and as taxpayers, whose government debt has almost doubled in the last two years alone, just as costs tied to benefits for retiring baby boomers are set to explode.”
Financial Times (Nov. 23, 2009)
Excerpt: “It is even easier to anticipate a sharp rise in bond yields – and a corresponding sharp fall in bond prices – particularly when central banks stop their quantitative easing programmes. Some smart hedge funds are betting on just that. Yet there has been precious little debate about whether banks should keep loading up on sovereign debt.”
Reuters (Nov. 20, 2009)
Excerpt: “Banks risk becoming addicted to cheap central bank cash used to fight the financial crisis and must prepare for its eventual withdrawal, the head of the ECB warned at a Frankfurt banking conference on Friday.”
Irish Independent (Nov. 10, 2009)
Excerpt: “THE UK is most likely to lose its ‘AAA’ status among those countries still in the top tier of sovereign credit ratings, the Fitch rating agency said yesterday.”
Creditflux (Nov. 20, 2009)
Excerpt: “Credit Derivatives Research reports that sovereign risk continued to rise this week as all members of its GRI index except Japan added risk. The Government Risk Index broke through the fifty basis point mark this week for the first time since late July. Japan’s standout rally came only after the name experienced a run up in risk the week before even as the other majors rose only modestly.”
Investment Outlook/Bill Gross, Pimco (Dec. 2009)
Except: “The Fed is trying to reflate the U.S. economy. The process of reflation involves lowering short-term rates to such a painful level that investors are forced or enticed to term out their short-term cash into higher-risk bonds or stocks. Once your cash has recapitalized and revitalized corporate America and homeowners, well, then the Fed will start to be concerned about inflation – not until. To date that transition is incomplete, mainly because mortgage refinancing and the purchase of new homes is being thwarted by significant changes in down payment requirements. The Treasury as well, has a significant average life extension of its own debt to foist on investors before the Fed can raise short-term Fed Funds.”