Unbalanced Books

24/10/2014 at 5:40 pm

A while ago, we looked at the re-entry of Greece into the bond market and noted that it could mark the beginning of the end of the sovereign debt crisis. This week, new borrowing figures for the UK reminded us how big a millstone borrowing can be around a country’s neck

The government is borrowing more this fiscal year than it did last time. This was not supposed to happen: the economy is growing at a fair lick, unemployment is falling, welfare spending and public sector pay has been capped and so on. Reasons for the disappointing outcome include weak earnings growth, a slower-than-expected housing market and the lower oil price. (It is worth observing that real wage compression in particular has been a persistent affliction here in Britain, with inflation-adjusted wages at the whole economy level almost 10% lower today than they were five years ago.)

It is still likely that our debt to GDP will peak in the next three years or so and gradually climb down below 90% again (on a Maastricht basis). But even at this level, and with very low rates, interest payments for 2015-16 are forecast at £59bn – more than the education budget and about 8% of total government spending.

Of course Britain is not alone in this position. Look around the developed world and sovereign balance sheets are, as a rule, stretched. The increase in US debt to GDP, which saw it rise from 63% in 2007 to over 100% five years later, has levelled off, but in money terms the country owes the staggering sum of $17.9trn. For the American fiscal year just ended, interest on this debt amounted to just under $431bn. That is getting on for an eighth of the Federal budget.

Eurozone debt was 90.9% of GDP last year and it still likely to rise with growth in the economy as anaemic as it is. In Japan, debt to GDP stands at over 210%, and last year the Japanese were still running a massive budget deficit (over 9%). Controlling this has consequences, as we saw earlier in the year when the sales tax increase came in and shrank the economy.

Japan is an interesting case for another reason, however. It is one of the world’s largest holders of reserve assets, with some $1.2trn in the bank. Only China has more (almost $4trn). Another country with huge reserves relative to GDP is Saudi Arabia, with $735bn worth against total output last year of $745bn. Neither China nor Saudi have a material level of sovereign debt (22% and 12% of GDP respectively).

Some of the results of this situation are obvious. On the one hand, highly indebted nations will spend many years paying huge amounts of interest and struggling to grow their way to more manageable debt positions. On the other, those nations with little debt and healthy reserves will profit from the interest payments. China owns about $1.3trn of US government debt. If this reflected the market as a whole the average coupon would be around 2.5%, so Uncle Sam would be paying the Chinese $32.5bn per year.

More interesting, perhaps, are the less obvious effects. It might come as a surprise but Saudi Arabia increased production of oil by 50,000 barrels a day last month. The IMF estimates that the Kingdom requires a price of $83.60 per barrel to balance its budget, which is about where oil is at the moment, but with no debt to speak of and huge reserves the Saudis can manage a few years of low prices. After all, their oil is still very profitable to extract at this level. And if it hurts the competition in Russia, poses a distant threat to shale exploitation in the US and possibly destabilizes Iran, it seems unlikely that Saudi Arabia will mind very much.

The global debt position has changed the balance of economic power. In addition to political consequences there have been and inevitably will be consequences for markets, not all of which will be intuitive. Finally, it is rather gloomy to reflect that the UK is not among the stronger nations on any measure now: our high debt ratio is accompanied by lower reserve assets than Poland and less gold than Venezuela.

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