Friday, July 23, 2010

Sovereign Default Risk

Please take a look at this fine analysis by Michael Pettis. It cuts through the nonsense about the almighty debt-to-GDP ratio that dominates current discussion. This ratio has no predictive power over sovereign default risk; much more depends on the composition of the debt, the volatility of the public revenue stream, and the forces acting upon creditors. Above all, there are moderately procyclical debt burdens (weak economy, weak burden) and monstrously countercyclical debt burdens. You want to assume the first and flee in terror from the second.

Pettis also points toward an interesting political economic aspect of the fundamental asymmetry between surplus and deficit countries. He writes:

A sovereign default is always a political decision, and it is easier to default if the creditors have little domestic political power or influence. Unless foreign investors have old-fashioned gunboats, or a monopoly of new financing, for example, it is generally safer to default on foreigners than on locals.

While credit markets may be segmented, being a deficit country increases the likelihood that sovereign debt will be held by foreigners. We often think of deficit countries as being weaker or more vulnerable, and they are, but governments often fear their domestic elites more than the global lords of finance.


Don Levit said...

Well, if the domestics are given priority over the foreigners, we better get our Social Security and Medicare programs more fully funded.
And, that goes for the retirement plans of federal employees, too.
The way I see it, there is absolutely no money in the fully accrued retirement plans for federal employees. I guess they will be paid by general revenues, totally.
At least Social Security has earmarked revenues to help pay for the benefits.
Don Levit

Jack said...

Well Don, it sure seems equitable to raise taxes on those who have been enjoying their taxation vacations for the past decade so that those federal, state and county emoployees who have been working for 20, 30 or 40 years at lower rates of pay based upon their contractual and legislated "fringe benefits" packages can actually collect on those contractual and legislated agreements.

TheTrucker said...

Son and Jack:

What we are witnessing is the people who got the tax cuts and employed SS trust fund money to hide the true deficits are now balking on paying back what they have "stolen". And it is essentially the same for the government retirement finds. The people who took those low paying jobs are owed the benefit they were promised just like the people who paid higher than necessary FICA taxes. In both cases the producers were _SAVING_ for their retirement. And the "owners" and the financiers were investing in China.

But it is not too late. We need rebated fossil fuel taxes and more importantly we need rebated import duties. All the rebates go to the middle class. And if you want to increase the levies then you can just fund a straight citizen's dividend.