From the front page of today's Financial Times of London....MatthewUS, Germany, France, UK face junk debt statusBy Päivi Munter in LondonPublished: March 20 2005 21:35 | Last updated: March 20 2005 21:35Rapidly rising pension and healthcare spending will reduce the debt status of the world's richest industrialised countries to junk within 30 years unless their governments move quickly to balance budgets and reduce outgoings, a report published on Monday warns.Standard & Poor's, the credit ratings agency, says if fiscal trends prevail, the cost of ageing populations will fuel downgrades of France, the US, Germany and the UK from investment grade to speculative, or junk, category France by the early 2020s, the US and Germany before 2030 and the UK before 2035. They are currently in the top Triple A category, ensuring they can borrow at low rates.The debt ratios of these countries are set to reach levels not seen since the second world war, S&P says. Moritz Kraemer, credit analyst at S&P, says: “Without further adjustment either to current fiscal stance or to social and healthcare costs, the general government debt ratios of France, Germany and the US will surpass 200 per cent. This will result in deficits more akin to those associated with speculative grade sovereigns.”All big industrialised nations face the problem of large unfunded pension liabilities and rising healthcare costs as populations age. Most have responded with limited moves to make benefits less generous.>But S&P's projections already factor in the reductions in public sector pensions made by Germany and Italy last year.The agency estimates that according to current trends US general government debt will soar to 239 per cent of gross domestic product by 2050, against 65 per cent today. France's will reach 235 per cent against 66 per cent, Germany's 221 per cent against 68 per cent, and the UK's 160 per cent against 42 per cent. Italy, which has run more disciplined budgets because of its already-high debt burden, will see its ratio fall to 91 per cent from 104 per cent, assuming it maintains the current trend.S&P said last year the debt ratio of Japan, the most heavily indebted industrialised country, was set to surpass 700 per cent of GDP by 2050.The agency's model shows countries can ease the impact of ageing by running tight budgets before demographic pressures peak. The US has healthier demographic trends than Europe but its budget deficit will add to the pain when population ageing accelerates about 2020. Find this article at: http://news.ft.com/cms/s/3460ab64-9982- ... s01=1.html

I also liked the linked articles "Baby boomers hold key to pensions conundrum" and "A case of pension deficit disorder".Does everyone still think defined benefit pensions, especially the big public one, are such a good idea?This is another case where I wish there were longer-term bonds being issued and outstanding, so I could see how 50-year rates would be reflecting the market's view on the future of the current majors. The 50+ year swap market I'm afraid is priced more off of credit risk than true expectations of long-term "riskless" rates.These countries may also face an acceleration problem; if they respond to their budget bloat by trying to excessively raise taxes on mobile, productive professionals, many of us will see how much higher a standard of living we would enjoy moving out of these countries, and further reducing the tax revenues of the heavy borrowers.Optimistically, I do see ways that the current majors should be able to grow their way beyond their debt burdens and prosper as they have so many times before, provided that lobbies like AARP aren't to successful in bringing them down...

This is another case where I wish there were longer-term bonds being issued and outstanding, so I could see how 50-year rates would be reflecting the market's view on the future of the current majors. The 50+ year swap market I'm afraid is priced more off of credit risk than true expectations of long-term "riskless" rates.Agreed. Not having 30-year governments denies us critical data and makes the markets less free and fair.Matthew

Are you serious?Is that what the U.S. Treasury's mandate is...to keep as many maturities in the debt mix so that market observers can check yields to see if things are fairly priced?I think the only stupid thing about getting rid of the U.S. 30yr bond was that Treasury did it during a time when rates were dropping precipitously.They could have locked in long term money at very good rates. They still can.

Does this make any sense? Suppose in 2050, political leaders have to choose among:(a) Cutting retirement payments,(b) Defaulting on government bonds,(c) Printing enough currency to avoid (a) and (b), or (d) Raising taxes and cutting non-retirement government expenditures(b) seems like the least likely choice. It creates the most political pain, does the most economic damage and does the least to solve the problem. Moreover, it renders all investments so risky that the concept of a credit rating becomes useless.I think so many things are going to change in the near future, that none of these choices will be relevant in 45 years. Choosing among them, I think the most reasonable response is not to count on retirement benefits in 2050, the next is not to count on the currency value, the next is not to count on low taxes and high levels of government expenditures. The least reasonable is to worry that everything will be fine except that government bond payments will be missed.

I agree wit your view Aaronto me (c) seems to be the most likely choice for a government facing low growth and high expenditures levels, unfortunately for most of us with long dated investments for retirement.

QuoteOriginally posted by: Jezza(c) seems to be the most likely choice for a government facing low growth and high expenditures levels, unfortunately for most of us with long dated investments for retirement.Just make sure they're not long-dated nominalinvestments.I never understood long-term bonds myself. You seem to get equity-level risks with fixed-income level returns.

(c) would make me glad I'm holding TIPS and foreign assets. The problem with the TIPS is that it still leaves an incentive for the government to create inflation, since their tax revenues are naturally indexed, but the taxes on my TIPS returns would make my real after-tax returns negative. Still I would prefer this to an outright tax hike, which would in my view accelerate economic problems.(a) is obviously the best choice economically, and the worst one politically unless young people start getting informed and votingThe problem is inertia. A program was put in place that made sense when people died yonger and had more children, and the program exploded just as this was quickly no longer being the demographic. There is a "ratchet" effect in taxes and government spending that makes things like these very difficult to remove, no matter how important it is that it happen immediately.

QuoteOriginally posted by: AaronQuoteOriginally posted by: Jezza(c) seems to be the most likely choice for a government facing low growth and high expenditures levels, unfortunately for most of us with long dated investments for retirement.Just make sure they're not long-dated nominalinvestments.I never understood long-term bonds myself. You seem to get equity-level risks with fixed-income level returns.Aaron,The big advantage of long-term bonds is that they (and their derivatives) are just about the only instrument that actually allow you to fix your income. If you know that $1M can give you a $50,000/year income for 10 years, and that you can live off that, you really don't care about the mark-to-market risk, and really are taking much less than equity risk for your needs (your main risk is that $50,000/year underestimates your actual income needss). The big disadvantage I see is that they are relatively tax-disadvantaged compared to equities, except for the minor nicety that the interest is exempt from state and local income taxes (which I have appreciated living in New York City and Northern California). Of course, if you are a pension fund or some other tax-advantaged entity with fixed liabilities, long bonds really are your best tool for matching assets and liabilities and almost completely offset any risk of a shortfall or surplus.There is also a demand for long bonds to hedge swaps, which I use to hedge IR risk. Personally, I also find it easier to take views are rates and IR volatilities than individual companies, so the risk/return on a short term bet on a long term bond often looks attractive when I'm right (no CEO to worry about going crazy).

QuoteOriginally posted by: AaronI never understood long-term bonds myself. You seem to get equity-level risks with fixed-income level returns.In the case of government bonds, it's also not clear to me that you are actually investing. You give someone money today. In exchange, he picks your pocket in 20 years and gives it back to you. The more you give him today, the more he takes in the future to give back to you.It's like a criminals' dilemma. The more bonds you own, the more he'll rob your neighbor. If the government promises you 100% interest and you have 100 neighbors, he can take 1% of it from you, 99% of it from your neighbors. It may be that for every dollar you spend in US treasuries, your own present value actually goes down by a cent. Does this force people to buy more treasuries?

Don't forget, he also spends the proceeds on you (or picks your pocket less today). And it's not him doing it, it's us.

If major governments cannot issue long term high grade debt, then precisely who is going to do it ?There's all sorts of users for these instruments like pension providers, and their easy path has been to buy government debt. So much so that the long end of the market behaves very differenrtly to how any model of prices vs risk should act.The realted question os how the market will behave as this happens. My intuition says that if S&P are right, supply/demand will hold yields down meaning that we have low yield high risk debt.I can't exactly predict the consequences of that dilemma, but it doesn't smell good.

QuoteOriginally posted by: AaronDon't forget, he also spends the proceeds on you (or picks your pocket less today). And it's not him doing it, it's us.WARNING: The following discusses politics with a touch of sarcasmI might agree that's true about city munis, but less true with state munis and in many ways outright hard to agree with nation-wide. A disproportionately high amount of my tax money get transferred to retirees in Florida, funds wars of questionable value to US citizens, subsidizes uneconomic industries in less urban areas, and gets wasted on projects in Nevada that I don't even know about compared to the amount that other US taxpayers send to New York. You could say I am lending Uncle Sam money today to give it to someone else, and then most of what I will be given back will be picked out of my pocket. (Heck they even get away with taxing the interest they pay on their own bonds)."Him" is an agent for "us" if our system of government effectively represents the interests of "us". The problem, in my biased political opinion, is that too much of "our" money gets into "his" hands, meaning that the special interests that lobby "him", imbalances in legislative representation, and a trend towards in too much federal uniformity, means that control over the hands that spend money on me are weaker than the hands that pick my pocket.My sources are only based on a few casual chats with traders in the UK, but from what I understand, people who work to earn about 6-7 figures pay roughly the same order of tax in New York as in London, but it seems the public services provided by those taxes are many more and quite a bit more visible in the UK. The only federal public service I see here on a regular basis are those of the SEC and USPS, and even those are largely funded by pay-per-use fees, rather than just general revenue. Much of the sidewalks, transportation, NYPD, NYFD, insurance regulation, local literacy, sewage, etc., were all funded by local taxes that amount to less than a third of what I send to Washington. Even within a state, I noticed that taxes levied in Northern California are commonly spent in Southern California.I'll probably start another thread on this, but I believe a large portion of the problem is the reliance of many western governments on taxing their citizens' income. Essentially that tells them: "if you work or make money, we'll tax you, but if you lose money, we might let you carry that against again in an other year", which amounts to taking a call option on someone's income. Another problem is that income taxes are a "speedbump" to more activity in the economy, saying: "everytime money changes hands, especially if you dare hire someone, we take a cut".

QuoteOriginally posted by: DCFCIf major governments cannot issue long term high grade debt, then precisely who is going to do it ? ING comes to mind as a candidate. After them I might pick any of the banks the BBA considers good enough to survey for LIBOR fixings. The question might then come to which country's currency might it be worth denominating this long term debt in, and I wounldn't rule out that in a world of fiat money, it would not be entirely impossible for transnational banks to issue their own currency, perhaps as a syndicate, essentially backed by their and other banks' debt in ways similar to FOMC activity in T-bonds. Granted this is pure speculation, but much of what makes money what it is does note require currency to be issued by a national government. The more fearful might run for gold, but many westerners, especially those born after WWII, are probably quite skepitcal about the merits of gold as money and would probably prefer ING-issued banknotes.QuoteThere's all sorts of users for these instruments like pension providers, and their easy path has been to buy government debt. So much so that the long end of the market behaves very differenrtly to how any model of prices vs risk should act.The realted question os how the market will behave as this happens. My intuition says that if S&P are right, supply/demand will hold yields down meaning that we have low yield high risk debt.I can't exactly predict the consequences of that dilemma, but it doesn't smell good.I'd say much of this is because of the perception that long term govies are still less credit risky than any long-term paper of any other issuing body. Even then, US pension providers desiring durations longer than 30 years have had to resort to equities or similar non-government investments. If the investment community as a whole (including their regulators) start seeing long term govies as being less safe than alternatives, they would probably switch to those alternatives. I would say that funds in emerging markets that tend to invest in US and European government debt are examples of this already of what might happen if our roles are reversed. What still makes me wonder a bit is that many of these funds are permitted (and perhaps even encouraged) by their regulators to bear the credit risk of their own home country.Overall, I see this as a good reason why I don't want some over-regulated manager running my pension money

QuoteOriginally posted by: exotiqQuoteOriginally posted by: DCFCIf major governments cannot issue long term high grade debt, then precisely who is going to do it ? ING comes to mind as a candidate. After them I might pick any of the banks the BBA considers good enough to survey for LIBOR fixings. I dont think the banks would do it. I thought the are really go-beweens who will repackage the government debt into more flexible swap agreements with a LIBOR/LIBID spread added on top. They certainly dont like long term commitments sitting on their balance sheets.Its in part the banks who have been calling for long debt to be issued in the UK and US so that they can more easily issue long swaps.At the end of the day long term risk is difficult to get rid off, try to hoist it onto government and it will just end up squeezing out and back onto society through tax hikes or whatever.Kind of makes equity not such a bad bet - huh?