me, we’re very committed to ensuring that the track record continues.
Schachne: Alan Greenspan said that there’s a 0% of the U.S. default on gov- ernment debt because the U.S. can always print money. If the U.S. tries to inflate away its debt, would S&P see that as default by another name?
Beers: That’s a great question. I think it comes up a lot and reflects a somewhat oversimplified view of credit risk. Let me illustrate that in a couple of ways. A couple years ago, Zimbabwe, which we don’t rate, had one of the world records, probably the fourth-highest hyper-inflation in history. As far as we can understand, they did default on some of their foreign currency obliga- tions over the years.
But the idea that very high rates of inflation can somehow reduce the burden of government debt that is asso- ciated with high creditworthiness is something that no reasonable person in the world would—and S&P’s method- ology just can’t—comprehend. Then there’s also a practical point. The U.S. government, like a lot of governments in the world, issues inflation-projected or inflation-linked debt.
So the U.S. government today on a significant and possibly growing propor- tion of its own obligations—alongside a large number of other governments that we rate around the world—not only is promising on its nominal debt to pay interest and principle on time and in full, but also with inflation-projected debt its making an extra promise, which is to protect the value of that debt against changes in prices.
So for those governments that have a significant and growing portion of infla- tion-linked debt, they’ve already given up the inflation weapon. If they wanted to reduce the real value of that debt, they’d have to default on inflation- linked bonds.
By the way, there are historical exam- ples of this. Brazil—investment-grade sovereign that it is today—is just one example of historically going back to the 1980s and the 1990s that actually
reneged in part on inflation-linked debt at that time. They did so by reducing, retrospectively, the real coupon on that inflation-linked debt.
So, printing money doesn’t deliver a ‘AAA’ rating. And there’s another more subtle point to make about high and volatile rates of inflation, which is the insidious effect that high and volatile rates of inflation have on your social and political institutions, and also on your economic performance, which of course, feeds back into your fiscal performance.
And that’s why we’ve also seen exam- ples historically of sovereigns restruc- turing their local currency debt (which they issue with their own currency) with their own central bank because after all of the insidious effects of inflation they try a variety of conventional and uncon- ventional ways to get out of it.
But one of the unconventional ways to get out of this treadmill of high infla- tion is to restructure your debt. So even with the printing press of a central bank, it doesn’t necessarily save you from debt restructuring. That’s the record of history.
Chambers: I would just add as a foot- note that the U.S. government, under existing criteria at least, defaulted on its debt in 1933 when Roosevelt abrogated the gold clauses on U.S. debt.
Schachne: Well David Beers, John Chambers, thank you very much for pro- viding more insight and transparency into the downgrade announcement on the U.S. rating. As David mentioned earlier, we will be publishing further details on the ripple effect and how it might affect spe- cific securities, which will be posted on www.standardandpoors.com. CW
Standard & Poor’s CreditWeek | August 17, 2011 16
David T. Beers London (44) 20-7176-7101
John Chambers, CFA New York (1) 212-438-7344
Nikola G. Swann, CFA, FRM Toronto (1) 416-507-2582
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