Social Cohesion and Sovereign Default

by: Felix Salmon

Gillian Tett has an interesting column today on the degree to which “social cohesion” determines whether or not a country in fiscal difficulties will end up defaulting on its debts. The Japanese, she says, are used to the idea of sharing the pain, and would probably not tear themselves apart should the country have to make painful fiscal cuts in order to remain current on its obligations. (Besides, given that 95% of Japanese government bonds are held domestically, a default would probably cause even more pain among the population as a whole.)

On the other hand, says Tett, the US is used to growing its way out of problems:

In the US, the government has less experience of dividing up a shrinking pool of resources. Instead, in a land built by pioneers, Americans prefer to spend time thinking about how to make the pie bigger – or to find fresh frontiers – than about making shared sacrifices.

Thus it remains an open question whether Washington will be able to slash without real political or social upheaval. Signs of tension are already there: Bill Gross of Pimco, for example, this week warned that “our [American] government does not work any more; or perhaps more accurately, when it does it works for special interests and not for the American people”.

I think that this issue of social cohesion has its limits: it’s hard to think of a more socially cohesive country than Iceland, for instance. And extremely heterogeneous and divided populations like that of Brazil have managed to stay current on their debts (I’m thinking 2002 here) even as everybody expected them to default.

What’s more, the really important thing here is what fund managers like Pimco think, not what ratings agencies think: we’re (thankfully) past the point at which a sovereign’s triple-A credit rating reassures investors that there’s no chance of default. After all, Moody’s was rating not only Iceland but also its banks as triple-A, as recently as 2007. And we know how that turned out. Ratings agencies might only now be thinking in terms of social cohesion, but bond investors have always considered it as a factor. And they’re the ones who really set prices and yields.