Wednesday, August 25, 2010

Morgan Stanley Warns Sovereign Debt Default Inevitable

After WWII, nations around the globe experienced a significant increase in births. These Baby Boomers are now at or approaching retirement age, and the associated costs will be a great burden to most societies.

Yet, as government revenues plummet in the worsening global recession, there is even less money to cover these massive retirement costs.

Governments have been financing their borrowing through debt sales, but falling revenues will make repayment a challenge.

According to Morgan Stanley, the chances of government default will increase in coming years.

“Governments will impose a loss on some of their stakeholders,” Arnaud Mares, an executive director at Morgan Stanley in London, wrote in a research report today. “The question is not whether they will renege on their promises, but rather upon which of their promises they will renege, and what form this default will take.” The sovereign-debt crisis is global “and it is not over,” the report said.

Mares said that analysts are paying too much attention to debt-to-GDP ratios, and they should instead be looking at available revenues.

For example, the US has a debt-to-revenue ratio of 358 percent, one of the highest among developed nations, according to the report.

Though the report found that, “Outright sovereign default in large advanced economies remains an extremely unlikely outcome," it also found that yields are so low — even relative to inflation — that they offer "very little protection against the credible threat of financial oppression in any form it might take.”

Mares noted that the worsening recession diminishes a government's ability to tax and increase revenues.

As a result, governments are left to issue ever more debt to finance their operations. The yields on Greek, Irish, and Portuguese debt have all risen to new highs recently.

Those yields reflect the market's view of growing risk. You have to wonder which gives first; the market's tolerance for this increasing risk, or governmental willingness / ability to service those debts.

One way or the other, this report — and the current bond market — serves as a warning to governments and investors around the world, alike.

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