Scott Mather, a top executive at leading bond fund Pacific Investment Management Company (PIMCO), predicts that “Britain’s sovereign debt rating could be downgraded within a year”. Mather told a briefing in Taipei this week that his company was “underweighting” the sovereign bonds of the UK, US, and other developed nations in his company’s mix of investments. From Reuters:
“Miracles are needed in the next six months in order to keep economic growth in the developed world,” Mather said.
PIMCO has been warning investors to stay away from developed countries like Britain with heavy debt burdens, recommending instead shifting assets to Asia and developing countries.
Mather also predicted that “Britain’s sovereign debt rating could be downgraded within a year.”
Buzz has been swirling around potential sovereign downgrades for months now, but it is interesting that a notable like Mather would make such a prediction. The reality is that there are several nations that should have been downgraded already, but it seems the ratings agencies prefer profits at the expense of objective ratings. Remember all those subprime-laden triple-A mortgage backed securities that turned out to be anything but?
If Britain gets downgraded, will the US be far behind? Not that Congress or the administration seem too worried about the prospect, but a US downgrade would force the federal government to borrow at much higher interest rates. With the federal deficit already running at around $1 to $1.5 trillion, higher borrowing costs could trigger a debt spiral leading to default, a major devaluation of the dollar (which will drive up prices for everything), higher taxes, or some combination of the three.
According to an IMF report released last year, the financial situation of the US appears even more dire than the UK. The IMF predicted that UK sovereign debt would reach 87.8% of GDP by 2014, yet US sovereign debt is already hovering around 90% of GDP and is predicted to reach 106.7% of GDP by 2014. The cynic in me believes that political considerations may override a ratings downgrade for the US, but if things get bad enough the ratings agencies will be forced to downgrade if they wish to maintain even the illusion of objectivity. It is obvious to anybody that government finances in the US are in bad shape and getting worse.
With a fiscal crisis on the horizon, I fear that our federal government may undertake desperate measures to keep the financial ship of state floating. There has been talk of “encouraging” 401K owners to reallocate their investments into Treasury debt, which would help finance government spending as foreign investors increasingly shy away from US government debt. The Federal Reserve may be forced to embark on a new “quantitative easing” program – essentially printing money – that could lead to higher prices in the future for everything you purchase. We may also see significantly higher taxes as a Congress and administration bent on increasing the size of government are forced to bring the books into balance.
-CH
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