Standard & Poor’s lowered its debt outlook for Britain from “stable” to “negative” a result of rising ratio of national debt to GDP. According to Bloomberg, Britain will need to sell 220 billion pounds ($334 billion) of bonds in the next fiscal year as GDP shrinks and the budget deficit rises to 175 billion pounds or 12.4% of GDP. The fear is that as the economy shrinks and debt grows the debt burden will reach 100% of GDP and remain there for the “medium term”. Presently, the U.K.’s debt load will reach 67% of GDP according to IMF estimates, which is lower than the 16-nation Euro zone average of 69% or the estimates for the U.S.A. of 70.4%. This is certainly not the first nation to be saddled by debt concerns as Spain, Portugal and Greece have all had their debt ratings lowered already. The report shows the concerns over the rate of growth of the nation’s debt (doubling by 2013) at a time when GDP is predicted to fall somewhere between 3%-4% in 2009. Accordingly, the FTSE dropped the most in 2 months and the pound dropped .7% against the dollar and the Euro.
Not to get ahead of ourselves, it is important to point out that the S&P warning suggests a 1 in 3 chance that the downgrade will actually occur given the current scenario. However, the implication here is obvious, the U.K. is getting ahead of itself spending-wise and a return to more fiscally conservative policies would help lower risk.
“The rating could be lowered if we conclude that, following the election, the next government’s fiscal consolidation plans are unlikely to put the U.K. debt burden on a secure downward trajectory over the medium term… Conversely, the outlook could be revised back to stable if comprehensive measures are implemented to place the public finances on a sustainable footing, or if fiscal outturns are more benign than we currently anticipate.” S&P Credit Analyst David Beers
The question that instantly comes to mind is could the same warning be in store for the U.S. economy. Government spending has been increased to a great degree in order to prop up the flagging economy of the U.S. as well, and to date their has been little sign of a fiscal restraint in the face of a shrinking tax base. There are only a handful of AAA rated companies left as even Berkshire Hathaway (BRK.B) and General Electric (GE) have lost their highest debt rating in the last two months. The remaining AAA-rated U.S. companies are Automatic Data Processing (ADP), Exxon Mobil (XOM), Johnson & Johnson (JNJ), Microsoft (MSFT), and Pfizer (PFE). Britain has zero remaining AAA rated companies.
John Mauldin’s Outside the Box E-Letter this week deals with the challenges facing the U.S. in regards to keeping its debt to GDP ratio in check in the coming years. I would highly recommend that anyone interested read this report by Dr. Horace “Woody” Brock, Ph. D., as it is an insight into some serious problems that we could be facing in the coming generation. An excerpt from the conclusion follows:
“This essay began with a demonstration of the all-important role of the evolution of a nation’s Debt-to-GDP ratio. The direction of this evolution is a good proxy for the future success or failure of the nation. We argued that a one-time shock (like today’s US recession) that drives the initial Debt ratio way up does not pose the problem most people assume. Long run recovery is possible, but only if policies are adopted that drive the growth rate of the numerator down, that of the denominator up, and thus that of the ratio down.
We then identified over a dozen policies that can achieve the goal of driving down the Debt-to-GDP ratio in the longer term. The End Game that is now being played is whether policies of this kind are adopted, or whether they are not. In our view, the Obama administration has adopted both a philosophical perspective and a set of policies that will drive the ratio up. If this is indeed the price of a “new American social architecture,” then it is a price that is too high.“