05 August, 2011

A question of maturity

Many years ago the head of the largest bank in the world, Walt Wriston, Chairman of Citibank, said ‘People go bust, countries don’t’. Shortly after he said this we had the debt restructurings in S.America and one wondered whether the great man hadn’t been talking complete tosh.

Now Big Walt is dead and his bank pretty well went belly up in the crisis, and the sovereign debt problem is closer to home: Italy, a G8 nation, is thought by many to be about to descend into the abyss.

So how does this work? How was Wriston wrong? Italy borrowed at presumably acceptable rates so unless the economy is going steadily backwards (it’s not, it’s just not going forward very fast) why should it not be able to pay?

This table shows the average maturity of a few countries’ debts in years:

Britain  13.8
Italy       7.1
Spain     6.2
Japan    5.8
USA      5.1

So the US has to refinance one fifth of its debt each year. Normally we would have said that is OK for the US because it is the richest country in the world with the most developed bond markets. These are not normal times, but that is a story for another post. Let’s compare Britain and Italy, two countries about the same size economically with the same population.

Britain has to refinance its debt every 13.8 years, that is to say about 7% of it each year, or in $ equivalent around $105bn. When the bond markets are in a bit of a spin (an understatement, I know) they mark up the rate a country will have to pay on its debt and that applies to the new debt, not the old. So the new rates Italy has to pay now, some 3% higher than at the start of the year, will be paid on the amount it refinances each year.

An extra 3% on borrowing costs would subject the UK taxpayer to $3bn in the first year, the same amount extra in the second, etc.

Italy not only has more debt, but has to refinance nearly double that percentage, around 14% or $350bn each year. So the extra 3% borrowing costs Italy has suffered will cost an extra $10bn each year, money which has to be borrowed.

In addition, any deficit adds to the overall debt and that would be new debt.

No one knows at which point Italy runs out of cash but many economists think the balance is tipped at around 7% -only 1% higher than now.

It’s close.

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