Tuesday, July 19, 2011

Old Age and Sovereign Debt Default

Interesting discussion of the negative relationship between the age of a country's population and propensity for sovereign debt default. What many people don't understand about sovereign debt is that it is usually unsecured, meaning that there is no collateral for lenders to claim if the borrower defaults. This is unlike other debt instruments such as mortgages or corporate bonds which are typically backed by real assets.

As such, lending to countries is pretty much dependent on the creditor's assessment of the borrower's ability, or perhaps more importantly the borrower's willingness, to pay.

It is likely that old age reduces willingness to pay. Paying back debt might cut into entitlements that older segments of the population enjoy, such as State provided health care and retirement benefits. People may be less willing to forego those benefits in lieu of using those economic resources to pay back loans.

If the country is too leveraged, however, then the point may be moot. Socialistic systems require ever more economic resources to keep the wheels on the wagon. Credit will be cut off, either thru default or by bond market shut down.

This is the central message of Reinhart and Rogoff (2009).

Reference

Reinhart, C.M. & Rogoff, K.S. 2009. This time is different: Eight centuries of financial folly. Princeton, NJ: Princeton University Press.

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