We are shocked, shocked, to read that governments of the largest welfare state nations may be unable to service their debts over time as an increasing fraction of their populations stop working and start collecting. This story explodes the mainstream finance view, which forms the basis of all financial asset pricing theory, that government bonds are “risk free”. A while back, during the Clinton era, when there were “surpluses as far as the eye could see”, some finincial writers even complained that when all of the US government debt was paid off that would make it difficult to price other finanical assets because of the lack of US treasuries as a benchmark.
London (Standard & Poor’s) March 21, 2005--Without concerted policy and fiscal reforms, aging populations will lead to intense pressure on the public finances and sovereign ratings of five of the world’s leading developed countries in the coming years, says a report published on March 18, 2005, by Standard & Poor’s Ratings Services.
The report, entitled “In The Long Run, We Are All Debt: Aging Societies And Sovereign Ratings,” is available on RatingsDirect, Standard & Poor’s Web-based credit analysis system, and covers the Republic of Italy (AA-/Stable/A-1+), together with the Federal Republic of Germany, the Republic of France, the United Kingdom, and the United States of America (all rated AAA/Stable/A-1+).
The study is part of a special report on social security, corporate pension plans and retirement savings to be published in Standard & Poor’s CreditWeek on March 30, 2005, which examines the effects of these programs on individuals, companies and financial markets.
“Without further adjustment either to the current fiscal stance or to social security and health care costs, the general government debt-to-GDP ratios of France, Germany, and the U.S. will surpass the 200% of GDP mark by the middle of the current century,” said Standard & Poor’s credit analyst Moritz Kraemer. “This will result in deficits that will be more akin to those currently associated with speculative-grade sovereigns.”
Assuming no change in their current fiscal stance and policies governing age-related spending, sovereign ratings could begin to fall from their current levels early in the next decade. By the 2020s, the downward pressure on ratings would greatly accelerate, and by the late-2030s, all but Italy would drop below the investment grade divide. This scenario is not a prediction by Standard & Poor’s.
It is a simulation that highlights the importance of age-related spending trends as a factor in the evolution of sovereign creditworthiness. In reality, it is highly unlikely that governments will allow debt and deficit burdens to spiral out of control.
The example of Italy in the past two decades is instructive: once governments are confronted with unsustainably rising debt burdens they do react, however reluctantly, by tightening the fiscal stance. Indeed, aging is only one force jeopardizing long-term fiscal solvency, with the weak fiscal starting position being another factor of similar importance.
If the governments examined were to start with balanced budgets in 2005, their debt ratios by 2050 would on average only be about one-half as large as under the scenario described above, even with no further reform aimed at squeezing age-related outlays.
“This forcefully underlines the need to embark on a prudent fiscal stance as early as possible to be able to better absorb the surge of entitlements ahead,” said Mr. Kraemer. “Although attempts to reform pensions and health care systems are welcome, their positive effects are diluted by the nonchalant attitude among governments with regard to fiscal consolidation here and now.”
