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.

European debt

In my post yesterday I warned that highly indebted countries on the European periphery would find it more difficult to raise money if new plans for restructuring went ahead.

Before the scheme is implemented, just on the announcement of what the Germans wanted, Irish debt became nearly a quarter of a percent more expensive. The Irish now pay more than 7% whereas the Germans pay 2.5%. Just yesterday's rise - as I say, while it is still a vague announcement - meant around another €1.50 a week per family in debt service.

The true level of debt

There is a suggestion doing the rounds that the IMF be called in immediately after the election in order to certify the level of debt.

I am not sure about the IMF - whose experts arriving on the Heathrow tarmac would cause the pound to fall out of bed - but I certainly think some independent body should do an audit, so the new government can at least know - and let the public know - how bad it is.

One thing which should be included is the PFI - the system of joint public and private sector projects initiated by Gordon Brown. After all, if the project fails and we are left with a half built hospital or school the government is going to be forced to finish it. So the taxpayer is on the hook for the whole of the money. This was just one of Gordon's little fiddles.

There will be more.

UK Elections: 4 The Deficit

Listening to the commentary on the budget, particularly on the BBC, there appears to be some confusion with the terms 'deficit' and 'borrowing'.

I am astounded that the Conservative Party allows the Government to get away with this.

Just to be clear, the deficit is the amount by which the government overspends each year. Each £1 of deficit amounts to an increase in borrowings of £1.

So when the Government says it will halve the deficit by 2014 it means that the amount of debt, which some day we have to pay off, will not be halved, but will still be going up. In 2014 the debt will still be increasing, but at a lower rate. Still going up, not down.

We need a surplus, remember that? a surplus to reduce the debt.

The debt must be reduced, and nothing else will do. Not a reduction of the deficit, a surplus, for several years.

This is no different from a family paying off its credit cards, which is happening all over Britain.

Ordinary people have understood it. The Government and the BBC have not.