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Will America Join the PIIGS Sty?


The facts suggest that the financial position of the US government may not be much better than that of Portugal, Italy, Ireland, Greece, or Spain.

Editor's Note: Read more from Michael Pollaro at The Contrarian Take.

The title of this essay may be a play on words, but the facts are nothing of the sort. Indeed, the facts suggest that the financial position of the US government may not be all that much better than the financial position of the governments of Portugal, Italy, Ireland, Greece, or Spain, the so-called PIIGS. In fact, given the agenda the Obama administration has set for America, one so far distinguished by ever larger government spending programs being financed by ever larger amounts of debt, the US government may be well on its way to becoming part of the PIIGS.

Sensationalism this is not.

Food for thought for holders of US Treasury bonds? You bet.

To see why, let's start with a snapshot of the sovereign debt risk metrics of the US government versus the PIIGS on fiscal year 2009 financials:

Sovereign Debt Risk Metrics -- United States versus the PIIGS, Fiscal Year 2009

The PIIGS are looking at some huge financial imbalances, that much is for sure. But I ask you, do the debt risk metrics of the US government look that much different? Is the debt of the US government, as S&P's triple-A credit rating suggests, that much more credit-worthy than the debt of say Spain, Ireland, or even Greece?

Let's have a look at each risk metric, the way a sovereign debt investor might, ranking the countries on those metrics from "bad" to "worse."

Economic Burden Metrics

The ability of a government to pay its bills ultimately comes down to the ability of its citizenry to produce income high enough to pay those bills. On this score, America isn't a country that many would want to emulate, showing Deficit to GDP and Debt to GDP ratios no better than the average PIIG:

Coverage Ratio Metrics

Financial analysts measure an entity's ability to pay its obligations in several ways. One popular way is through a metric known as a coverage ratio. In this sovereign risk study, I offer up two coverage ratios:

1. Receipts to Outlays, measuring a government's ability to fund its spending needs via current tax receipts, with a ratio of less than one -- meaning that that spending is being financed by deferring the costs of that spending into the future via the issuance of debt; and

2. Gross Debt to Receipts, representing the number of years it will take a government to repay its debt obligations at its current level of tax receipts, debt obligations incurred as a result of years of opting to finance its spending the easy way -- via debt issuance instead of via current tax receipts.

On both these risk metrics, the US is at the bottom of the list by a country mile.

Size of Government

America has one big thing going for it: the size of its government relative to the size of its economy is, on a comparative basis, relatively small, taking some 25% of the economy versus the roughly 50% taken by the PIIGS. That implies that America's ability to grow its income and pay its bills is better than that of the countries of the PIIGS. Have a look at the numbers:

At first glance, and as a holder of US Treasury bonds, perhaps this is reason for hope, and reason for that triple-A rating. But a deeper dive into the particulars suggests something quite different.

Since 2000, the US government's spending bill has been growing at an annual rate of about 8% -- more than double the rate seen in the 1990s -- and a trend that's taken government spending from about 18% of GDP in 2000 to today's 25%. Add $100 trillion-plus and counting in unfunded-liabilities-come-spending into the mix, as well as a host of economically debilitating tax rate hikes beginning as soon as 2011, and you have the makings of an economy that will be increasingly burdened by the government, making it harder and harder for the government to pay its bills. And may I say, all this without the US Congress creating even one more government program.

Maybe not today's problem, but looking forward, a bad omen for all holders of US Treasury bonds, especially given the debt hole America has already dug for itself.

Debt Risk Metric Scorecard

Borrowing a tool used by baseball, let's recap by constructing a Sovereign Debt Risk Scorecard. Again, going from bad to worse, America on this metric is near the bottom of the list:

Granted, these are but a few summary metrics. Granted, the average risk metric so computed is a simple, unweighted, arithmetic average. But if these numbers don't make you think -- think that America's triple-A status may be a bit too "generous" -- then may I suggest you could be guilty of not thinking. Not something I'd recommend if you are, or plan to be an investor in US government debt obligations.

IMF Looks Ahead and Doesn't Like What It Sees

In its April 20 2010 Global Financial Stability Report, the International Monetary Fund (IMF) warned that government risk in the advanced economies is now the biggest threat to the world economy. These governments, the IMF correctly observes, not only took on many of the bad debts incurred by private institutions these past several years, but due to the economic fallout of the crisis and the existence of a plethora of government social nets, these governments face continuing heavy borrowing needs for at least the next few years. An ugly situation for sure, and one the IMF said could get out of hand, and fast, if not addressed.

In conjunction with the release of the report, José Viñals, Financial Counselor and Director of the IMF's Monetary and Capital Markets Department, said:

"In spite of recent improvements in the outlook and the health of the global financial system, stability is not yet assured.… If the legacy of the present crisis and emerging sovereign risks are not addressed, we run the very real risk of undermining the recovery and extending the financial crisis into a new phase."

This author couldn't have said it better.

Yet, in 2010, the US Congress passed the largest government-spending initiative in history in Obamacare. Now, those same politicians are talking about cap and trade, not to mention even more stimulus programs. This, on top of those already horrible 2009 debt risk metrics.

Clearly, America isn't addressing the seriousness of its financial state.

Indeed, the IMF put pen to paper, suggesting the very same thing about America. This, taken from the IMF's World Economic Outlook Database:

America, on the basis of these metrics, says the IMF is a nation going in the wrong direction. With an estimated Deficit to GDP ratio of 10.97% in 2010, only Ireland is expected to show a ratio worse than the US

America Is NOT a PIIG?

Surely, you say, America isn't a Greece, an Ireland, or even a Spain. And in a sense, you'd be correct. Just not in the way you think. For in one very important respect, America is potentially worse -- a lot worse.

You see, America has the Federal Reserve's printing press. Steward of the world's reserve currency, America issues debt in a currency it alone can print. America can, in no uncertain terms, inflate its debt away, without limitation, with a few taps on a computer.

Portugal, Italy, Ireland, Greece, and Spain -- members of the eurozone -- are countries without a printing press. They can't bail themselves out by printing money to pay for their debts. No, as we're witnessing in this, the latest financial crisis, they have to show at least some manner of fiscal austerity before they can get access to the printing press of the European Central Bank.

Can the same be said about America?

In essence, the Federal Reserve's printing press is buying time for America. It allows America to kick the debt-can down the road a bit longer, no holds barred -- an option not available to the PIIGS. The result: the appearance that America is in control, its finances manageable; nothing at all like the finances of the PIIGS.

The problem is that same printing press eventually makes matters worse, because it fosters even more irresponsibility on the part of politicians, allowing them to hand out economic goodies without thought; without ever having to ask a single voter to pay for them. And as a result, the debt-can gets ever bigger, while the urge to inflate it away gets ever stronger.

Isn't this exactly what we say is happening in America right now?

One day this debt-can, and perhaps by that time the mother of all cans, will have to be paid in full. The only question will be whether that payment will be via fiscal austerity or via the debasement of the currency in which that can is priced.

One thing is for sure: If you want to wreck a country's economy, and its sovereign credit risk to boot, you do it with a printing press. And if it comes to this, you can be equally sure that US Treasury bond investors will be all over it, because at that point it will be clear to all that the last investor out is going to be an investor holding a can with nothing in it but worthless pieces of paper.

Final Thoughts

Right now, US Treasury bonds are in rally mode, as shock over the crisis in Europe is chasing both hot and scared money into the US Treasury market. This is the reason the US, home to the largest government-fixed income market in the world and owner of the world's reserve currency, is still viewed by many as the safe haven of choice. At the very least, the best of the worst, on the belief that America won't go down -- at least not yet.

And you know what? As negative as this author is on America's sovereign credit, that assessment is largely correct -- for now.

But in my book, and I think in the books of a growing number of US Treasury bond investors the world over, it's rent-a-bond -- not buy-a-bond -- when it comes to America's sovereign debt. Indeed, for the reasons discussed in this essay and explored in depth in this series, America's increasingly ugly sovereign risk metrics won't go unnoticed forever. They can't -- for the path America is on is simply unsustainable. In fact, if America doesn't heed the advice of the IMF, it may one day end up just like lowly Greece.

US Treasury bond holders will see to it.

For more on the US government's financial condition, click here.
No positions in stocks mentioned.

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