I was sent an email over the weekend from a fellow value investor who had attended the recent Value Investing Congress in New York. He loosely quoted Kyle Bass, one of the presenters, saying that the ‘United States could still, hypothetically, fix the long term problems but there is no way, politically, that is a possibility’.
That concept ties in quite nicely with one of the main themes of This time is different: Eight Centuries of Financial Folly. Carmen Reinhart and Kenneth Rogoff, the authors of this indispensable guide to government default over the past 800 years, go to some lengths to point out that most sovereign defaults don’t occur because a country can’t pay.
They occur because a country’s leaders choose not to repay the debts. The vast majority of sovereign defaults (there have been hundreds) have occurred with debt to GDP ratios of less than 60%.
History has shown that when the political costs of forcing fiscal adjustment on a country’s people is greater than the financial costs of defaulting, politicians will choose to default (or ‘restructure’ in modern language). This, presumably, is what Bass was getting at.
Mathematically it’s not the slightest problem for the US to meet its obligations. All it requires is a relatively minor adjustment to the trajectory of its occupants’ standard of living over the next 100 years. Whether its constituents are prepared to make the necessary sacrifices is an altogether different question.
If it’s not politically possible to fix the problems in the US, then the troubled European countries are no chance. Witness millions of protesters on the Paris boulevards outraged at the government’s attempts to raise the retirement age from, wait for it, 60 to 62. When the average life expectancy was 65, a retirement age of 60 made some sense. Now life expectancy is 80. And most young Europeans see it as a divine right to study (at the government’s expense) until they are 30.
That leaves the French 30 years of work out of 80 years of life (35 hours a week, mind you). It’s farcical and yet, when the government tries to change it by a relatively minor two years, the population brings the country to a standstill.
France, along with most of its European neighbours, needs much bigger changes than a two year increase in the retirement age to meet its future obligations. Doing so is going to be a battle between politics and finances. The images of the past week are a timely reminder of a lesson repeated many times throughout history: it’s usually the politics that wins.
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.