Ask Not Whether Governments Will Default...

Generali

....but how. (at least according to Morgan Stanley anyway).

Morgan Stanley have brought out a very interesting piece of research, reproduced in part in the FT. I can't link to the whole thing as it's not generally available but I can try to summarise it:

- It's not debt:GDP that matters, it's debt:taxes. The UK for example has a debt:GDP ratio of 68.1% and a debt:tax ratio of 168%, the numbers for the US are 53% and 358% repectively.
- Missing liabilities (covered elsewhere) but basically, the Government has promised people pensions, health care etc in the future but has not accounted for them
- The problem that missing liabilities cause is not a current but a future problem. Debt:GDP is backward looking.

So what to do about these analytical problems? Morgan Stanley create a Government balance sheet.

Assets:
Power to tax
Real Assets (buildings etc)
Equity holdings (eg stakes in nationalised companies like banks)
Other assets (eg cash)

Liabilities:
Social liabilities (eg unfunded pensions)
Gross debt

Assets - Liabilities = People's Equity (this is just like a real balance sheet. If you take the assets and subtract the liabilities, you are left with the value of the entity)

People's equity can be seen as a measure of Government solvency. Clearly if your assets are less than your liabilities then you are in trouble. With the calculation above, MS reckon that either taxpayers must suffer by paying more, holders of debt must suffer by receiving less or people receiving public services will get less in future (including future pensions).

For the UK they estimate People's Equity to be -1,000% of GDP. By contrast, Greece is -1,600% and Germany -500% of GDP.

They go on to finish by looking at how to default. The obvious thing is to stop paying debts. The less obvious is to default by stealth, something that is already happening by inflation being above target and increasing the age of retirement.

They finish:

History is not so reassuring after all. [FONT=Arial,Arial][FONT=Arial,Arial]Financial oppression has taken place in the past as an alternative to default in countries that are generally considered to have a spotless sovereign credit record. Examples include: the revocation of gold clauses in bond contracts by the Roosevelt administration in 1934; the experience by then Chancellor of the Exchequer Hugh Dalton of issuing perpetual debt at an artificially low yield of 2.5% in the UK in 1946-47; and post-war inflationary episodes, notably in France (post both world wars), in the UK [/FONT][/FONT][FONT=Arial,Arial][FONT=Arial,Arial]and in the US (post World War II).

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Wookster

How on earth does one make a reasonable measure of the value of the "power to tax"?

There are so many subjective inputs (like economic growth, inflation, discount rate, number of taxable incomes - which is subject to migration both in and out, average incomes and so on.

It sounds a bit like the IRFS on pension funds/ share based payments - logically thought out but extremely difficult to put into practice in any sensible way.

In anycase, I'd be quite surprised if anyone thinks the current financial model is sustainable indefinitely.

CLAPTON

there is of course no possibility of increased productivity or new inventions or any of that stuff that may, just may allow a continuation of the post war (2) prosperity?

carolt

CLAPTON wrote: »

there is of course no possibility of increased productivity or new inventions or any of that stuff that may, just may allow a continuation of the post war (2) prosperity?

A possibility is not guaranteed, though, is it?

Worth looking the more unpleasant possibilities in the eye.

Generali

CLAPTON wrote: »

there is of course no possibility of increased productivity or new inventions or any of that stuff that may, just may allow a continuation of the post war (2) prosperity?

They take into account continued economic growth at a the 'natural' rate for an economy (eg about 2-2.5% for the UK).

Clearly they can't take into account a revolutionary technology that changes everything as by definition that is unpredictable.

michaels

As noted, retirement ages rise, pension taxation increases, health drugs are rationed, debt is inflated away, access to education is restricted and prices increased etc etc - I don't feel the future liabilities are set in stone.

The way I see it is that productivity growth and demographics will determine national output and politics will determine how this output is shared, money is just a nominal way of counting what is going on.

Radiantsoul

It would be interesting to see how these ratios have changed over time. It might well be that almost every government, at almost every point in history is virtually insolvent.

StevieJ

Does power to tax mean future tax/NI revenues?

Generali

StevieJ wrote: »

Does power to tax mean future tax/NI revenues?

It means the ability to raise taxes from the economy so yes, the net present value of all non-trading Government revenue.

GDB2222

So, if the tax take is around the maximum, what do you do? Raising tax rates doesn't raise any more money if you are at the optimal rates. Raising pension age doesn't help much either, as it shuffles the unemployment between generations and/or pushes expenditure from pensions onto social security. Inflation is the obvious way out, and it's been tried lots of times, but of course it only really helps with fixed liabilities, eg gilts, not things like pension commitments.

Generali

GDB2222 wrote: »

So, if the tax take is around the maximum, what do you do? Raising tax rates doesn't raise any more money if you are at the optimal rates. Raising pension age doesn't help much either, as it shuffles the unemployment between generations and/or pushes expenditure from pensions onto social security. Inflation is the obvious way out, and it's been tried lots of times, but of course it only really helps with fixed liabilities, eg gilts, not things like pension commitments.

The researchers think the only way out is default or defaults.