When even S&P tells you that within 5 decades, nearly two-thirds of the world will be junk rated, you know it is time to close the history books on the current system. In a long-overdue analysis on the impact of demographics, titled, "Global Aging 2010: An Irreversible Truth", S&P analyst Marko Mrsnik, who made Greece's shitlist earlier this year for being the first to downgrade the country and set off the European scramble to launch a $1 trillion rescue package for the European dominoes, has come up with the first report that acknowledges that not only is the US and UK AAA rating not set in stone, but, far more surprisingly, is the admission that the current system is set on an unsustainable course. To wit:as the chart below suggests, S&P now expects that the number of countries rated "spec grade" to increase from 18% currently in a hypothetical sovereign ratings distribution, to over 60% by the late 2040s as deficit spending (and debt funding) explodes. Additionally, in a world attached to reality, the credit matrix would make the AAA sovereign rating history by 2030. Of course, this being S&P, the rating agency is terrified of actually confirming what everyone knows, and qualifies this as follows: "The hypothetical ratings should be regarded more appropriately as an illustration of the credit dimension and profile of the demographic challenge that governments face and not as an indication of expected credit performance." Alas, the real, non-hypothetical outcome will be far worse: As Mrsnik himself says later, "The challenges ahead are daunting for the vast majority of sovereigns covered in this survey, particularly in cases where market pressures are pushing policy makers to embrace budgetary consolidation simultaneously with structural reforms of pension and health-care systems. For some sovereigns, this may put the relationship between the state and electorate under strain and severely test social cohesion." Translation: war.
On sovereign rating distributions:
Rising deficits likely would lead to downward pressure on our hypothetical sovereign ratings. This would be the case even if debt ratios remained at relatively low levels because of the sharp upward trajectory of fiscal deficits. When presented graphically, the collective deterioration in the hypothetical ratings on the 49 sovereigns in our sample becomes clearly evident (see chart 10). The erosion in sovereign ratings would start in 2015, when hypothetical ratings on a number of highly rated sovereigns come under pressure (see "Methodological And Data Supplement" for explanations of the model). Although the downward drift is impressive by any standards, equally noteworthy is the nonlinearity of the change in theoretical ratings over time. Ratings would weaken somewhat in the second part of this decade, especially at the upper end of the rating scale, while the number of sovereigns with speculative grade ratings would fall until 2020. From that moment onward, as the full budgetary impact of population aging kicks in, the projected downward transition in sovereign ratings becomes predominant. Before then, in the real world beyond "fiscal autopilot," there could well be the risk of a mistaken sense of security taking hold that works against the changes necessary to manage the rising fiscal pressures in future years.
The hypothetical ratings evolution shown here is derived by taking into account GDP per capita, general government balances, and net debt levels, and are not intended to serve as a prediction of actual outcomes (see chart 10). In practice, the hypothetical ratings may overstate the decline in creditworthiness. They are benchmarked against budget balances, net debt, and GDP per capita levels today, whereas it is of course possible that the medians themselves could worsen as an ever-larger number of rated sovereigns is squeezed by the costs of their aging populations. Moreover, Standard & Poor's may give more credence to mitigating credit strengths than assumed in the model. The hypothetical ratings should therefore be regarded more appropriately as an illustration of the credit dimension and profile of the demographic challenge that governments face and not as an indication of expected credit performance.
And in an ironic twist, we read the first ever Mea Culpa issued by S&P, when the rater confirms its rose-colored glasses bias from as recently as 4 years ago.
From Bad To Worse: Comparison With Previous Standard & Poor's Reports On Population Aging
For the sovereigns covered in our previous reports, the difference between this year's results and those published in 2006 and 2007 appear significant (see charts 19 and 20). First and foremost, the difference in our view appears to be a consequence of a significant deterioration in their general government balances and net debt levels since 2007 due to the onset of the economic and financial crisis. While the initial budgetary situation actually improved between 2006 and 2007, since then, the widening of fiscal gaps and rises in debt outstanding has been substantial. This puts the sovereigns in a relatively more unfavorable position in our long-term simulations of public finance indicators.
The report also includes updated long-term projections on real GDP and individual age-related spending items. In this context, there is a significant change as far as the long-term projection of health-care spending in the EU is concerned. To more completely capture nondemographic factors, which had been the main driver of increases in health-care costs in the past for EU sovereigns, we apply the so-called "technology" scenario as opposed to the "AWG reference" scenario, applied previously. The "AWG reference" scenario is in our view tilted toward the optimistic side as it does not fully recognize the past drivers of growth in health-care spending (see table 9 below).
And here is S&P's prescription for a doomed world:
The challenges ahead are daunting for the vast majority of sovereigns covered in this survey, particularly in cases where market pressures are pushing policy makers to embrace budgetary consolidation simultaneously with structural reforms of pension and health-care systems. For some sovereigns, this may put the relationship between the state and electorate under strain and severely test social cohesion.
Nevertheless, our study suggests that unless advanced sovereigns embrace reforms at a faster pace, the fiscal pressures will become increasingly unsustainable. At the same time, the aging demographic profile of their electorates could well make the political climate for reforming pension and health-care programs even more difficult than it is currently.
Against this background, we believe that growing age-related fiscal pressures call for decisive policy responses by governments in many countries quite soon –- and certainly over the coming decade. As we outline in this report, we do not believe that higher economic growth, if it can be generated, alone will suffice to tame future fiscal pressures. That said, we expect that a crucial growth-friendly policy that many governments will have to embrace is to find ways to encourage their people to remain active members of the labor force for many more years than is the norm today.
At the same time, for a growing number of sovereigns, the need to tackle fiscal deficits and implement pension and health-care reforms over the coming decade is a pressing policy issue, given the rapid growth in government debt burdens. This is an important policy issue not just from the standpoint of maintaining the creditworthiness of sovereigns and the sustainability of their public finances. At least as important, in our view, is that it may be vital to maintaining social stability. After all, changing the scope of public pension and health-care provision can, if embraced soon enough, help spread the impact over an extended period, with the burden of adjustment shared across generations of taxpayers and voters.
What a polite way of Mr. Mrsnik to say it's game over.
Full S&P report link