At one time it was unthinkable that General Motors Corp.’s bonds would ever be anything but investment grade, or that the debt of major G-7 countries would get little respect. Times are changing, however, partly because aging populations are putting pressure on businesses and governments’ health and welfare budgets.

The fall of GM bonds to near junk status heralded what could be a long slide in the ratings of formerly senior debt. Richard Gluck, a principal at Trilogy Advisors LLC in New York and manager of the $300-million CI Global Bond Fund, says GM’s problems “are typical of the industrial sector. GM has commitments to retirees and to current workers’ health care. In terms of sovereign debt, G-7 nations suffering a dearth of births have fewer workers to support dependents
than they had when their social programs were put into place.”

A heightened awareness of the perils of investing in superior credit hit financial markets March 16, when GM announced it expects to earn US$1-US$2 a share in 2005, less than half its previous forecast of US$4-US$5. Recently, an analyst at Swiss-based securities firm UBS lowered GM’s 2005 profit outlook to US50¢ a share and suggested its US50¢ quarterly dividend is at risk.

GM has been yanked down to a BBB minus by Fitch Ratings Ltd., just one very small notch above junk. Moody’s Investors Service put GM bonds on review for a possible downgrade to junk. Following the earnings warnings, GM bonds have recently yielded 9.59%, while Ford Motor Co.’s 30-year bonds recently yielded 9.25% if held to maturity —roughly double what long U.S.
treasuries pay. If the bonds fell to junk status, and institutions that are forbidden to hold junk were to sell them at distressed prices, a snowball effect would further drive up yields. For holders of GM debt, the world is a very different place than in the early 1990s, when GM debt got an investment-grade AA minus rating from Standard & Poor’s Corp.

What’s happening to GM’s debt, which totalled about US$301 billion at the end of 2004, is similar to what is occurring to the debt of G-7 sovereign issuers. Rising health-care and pension costs — the main causes of GM’s woes — threaten to impair the ability of major borrowers to service bonds in foreign currencies.

A recent S&P report prepared by Moritz Kraemer of the credit rater’s London office, says if current tax trends do not change the cost of serving the social security requirements of the aging populations of the European Union — not to mention Japan, whose population is already shrinking — public debt levels will match those that existed before 1950. Back then, the costs of war finances had crippled the European victor states and bankrupted the losers.

S&P data estimate U.S. general government debt will reach 239% of GDP by 2050, vs the current 65%. France’s debt is expected to reach 235%, vs 66% today; Germany’s 221% vs 68%, and Britain’s 160% vs 42%.
Italy, an exception, will see its debt fall to 91% of GDP by 2050 from 104% today.

The outlook for Canada’s public debt, 31% of GDP, according to the February federal budget, is more favourable, says Aaron Gampel, Bank of Nova Scotia deputy chief economist in Toronto. “The government of Canada has been paying down debt, even as G-7 partners have been adding to their debt,” he says. “That gives us more fiscal flexibility in the years ahead as we try to meet demographic challenges. We are in a better position to deal with the issues.” The budget projects total government health-care spending to rise to 11.2% of total spending in 2050 from 7.1% in 2004 — a large jump but far more manageable than the spending implied in other G-7 demographic forecasts.

Rising ratios of public debt to GDP will have an ominous effect on the ability of the U.S.
and most G-7 nations to pay their bills, says the Kraemer report. “All [European] ratings, Italy excepted, would come under severe pressure, and all would eventually display fiscal characteristics that would better befit speculative-grade sovereigns,” S&P gloomsters predict.

In effect, the S&P rating of sovereign U.S., German, French and British debt will fall from the current AAA ratings to sub-investment- grade speculative levels.
France will achieve junk status between 2020 and 2025, Germany between 2025 and 2030, the U.S. around 2029 and Britain by 2035, the report forecasts.