While it might seem like somewhat stating the obvious, it is nonetheless worth driving home to the politicians and public policy wonks who see rates at record lows and perceive a Keynesian borrow-and-spend-fest as once again the solution to borrowing-and-spending too much. As Morgan Stanley puts it, fiscal policy is sailing between the Scylla of chase-your-tail austerity and the Charybdis of sovereign insolvency. In short, it is impossible for developed market (DM) governments to grow their way back to solvency. Doing nothing would sail governments towards the whirlpool of national insolvency – at some stage. But avoiding insolvency would risk being monstered by recession. If 'expansionary austerity' worked, then Europe would now be booming. The outlook for fiscal policy and public sector finances is a major uncertainty for investors and, critically, is part of the reason why risky assets are being de-rated and 'safe' assets are at unprecedented valuations.
Morgan Stanley:The Strait of Mess
Fiscal policy is sailing between the Scylla of chase-your-tail austerity and the Charybdis of sovereign insolvency. It may be possible – with perfect foresight, untrammeled authority, tolerant markets, accommodating central banks and a disregard for political pressure – to navigate between these two threats. History suggests otherwise. Either way, this adds what is likely to be a long-running element of political and financial risk to the investment outlook. Markets are reacting by increasing the rating on ‘safe’ assets, and de-rating riskier assets, including equities.
Most DM governments are essentially broke. Of course, governments are not businesses, so the usual rules do not apply. But it seems that the net present value of governments’ liabilities – including the commitments embodied in current social security policies – exceed the net present value of their assets (including yet-to-be collected tax receipts). Exhibit 1 shows estimates of the (negative) net worth of some G-10 governments, relative to current-day GDP.