John Maxfield says “Goodbye to Safe Assets”:
For much of the past decade, it was presumed that the debt of developed economies was risk-free. This is why a full $38 trillion, or more than 51%, of the world’s total outstanding marketable safe assets is investment-grade sovereign securities — that is, government bonds.
However, the financial crisis has shown the folly of this presumption. While 68% of advanced economies carried a AAA rating five years ago, the proportion had dropped to 52% by the end of last year, as countries like the United States, France, and Spain all lost their coveted AAA status. And the same trend can be seen in the movement of sovereign bond yields in advanced economies. Prior to 2008, the yields moved in harmony. After 2008, individual countries started peeling away. Greece was the first to depart, followed by Portugal, and then Spain, Italy, and Belgium. All told, $15 trillion in investment-grade sovereign debt has been downgraded.
Why is this happening? Quite simply, countries are far too leveraged. The debt-to-GDP ratio of the euro area went from 66% in 2008 to 85% last year. The United States’ went from 64% to 93%. And Japan went from an already-high 188% to an even higher 220%. While the total general government gross debt of advanced economies amounts to more than $47 trillion today — this includes both investment-grade and non-investment-grade sovereign bonds — the IMF projects this figure will rise to $58 trillion by 2016, an increase of 38%.
In an era of rising debt-to-GDP ratios of developed governments, labels such as “safe” and “risky” are likely to be fluid. It’s entirely possible that asset classes previously considered risky will be the ones that ultimately prove to be the safest from the perspective of preserving purchasing power. Asset allocations that remain flexible enough to respond to unfolding developments are the ones most likely to succeed going forward.
