Hamish McRae: Why some types of debt are more important than others
Thursday 19 January 2012
Your starter for one: if you add all of a country's debt together – personal debt, company debt, bank debt and government debt – which country carries more debt relative to GDP: Germany or Greece?
Well, it is Germany. Greece does have very high government debt, currently 132 per cent of GDP and it is rising further. But it has relatively little bank debt and personal debt. By contrast Germany has lower government debt at only 83 per cent of GDP, but it has a lot of bank debt and so its total load is higher. So the level of a country's debt does not matter, at least as far as the markets are concerned, provided it is deemed to be the right sort of debt and the country has a credible plan to get it down.
Thus the UK, with total debts of five times GDP, manages to retain its AAA rating and have 10-year debt trading at below 2 per cent, while France, with debts of only three-and-a-half times GDP, lost its AAA rating and, even ahead of the downgrade, had 10-year debt trading at more than 3 per cent.
Or take the relative position of Denmark and Germany. Both have a AAA rating. But Denmark has the highest household debt burden in the world, on one tally more than three-times GDP, while Germany has one of the lowest such debt. Yet in the past few days at least, Danish government debt has been trading at an even lower interest rate than German: 10-year yields are around 1.7 per cent, whereas German yields are 1.8 per cent.
Now this may be because the markets are starting to have worries about the burden on Germany from its need to bail out the rest of the eurozone – this point was made by Louise Cooper at BGC Partners yesterday – so Denmark is gaining favour because it has kept the krone. It also has low public debt and a current account surplus. But for whatever reason, the fact remains that the markets seem relaxed about household debt.
You can see the way the debt burden of the major countries, plus those caught up in the eurozone crisis, in the graph. This comes from a study by McKinsey Global Institute, published today, which updates the work it did last year on debt levels.
The focus this year is more the rate at which different countries are getting their debts down rather than the levels as such, but as you can see, of the five countries swept up in the eurozone crisis, only Ireland has overall debts that exceed those of Japan and the UK.
So, you might ask, why are some countries unable to borrow at acceptable rates, while others with even higher debts are able to do so?
The answer comes in several parts. First, the type of debt does matter. Household debt is widely spread, and insofar as it has been for home purchase, is backed by assets. Government debt is not spread at all and is backed mainly by the willingness of a country's taxpayers to pay it back. Countries do own assets that can be sold – Greece has sold a long lease on the port of Piraeus to the Chinese – but the real backing is the tax revenues it can sustain. If people won't or can't pay the taxes there is a problem.
In the case of Greece, holders of its debt have been criticised for wanting their money back, which is a great way to encourage other potential investors to pick up the distressed debt from other troubled countries. It now looks as through the payout to Greek bondholders will be less than 40 cents in the euro, which does not seem a lot given the country's overall debt level.
Another part of the answer is that the profile debt matters: whether it faces early repayment.
The profile matters because if a country has a lot of debt to roll over, as Italy does in the next few months, it faces a market test every few days. Every time some debt falls due it has to go back and see if it can persuade investors that it is good for the money.
The direction of the debt burden matters too, because if the overall burden is rising and no end is in sight, investors naturally run scared. Here the McKinsey study has some interesting new data. To simplify, the whole process of de-leveraging is still in its early stages. Only three of the countries it studied, the US, Korea and Australia, have lower overall debt levels than at the beginning of the financial crisis in 2008. The US has made more progress than anyone else.
By contrast, the UK and Spain have only just begun to cut their overall debt ratios – as far as Britain is concerned, individuals are starting to cut their debts, but this is more than offset by the rise in government debt.
McKinsey sees light at the end of the tunnel for the US, but comments that "no country has all the conditions in place to revive growth".
There is a temptation to take all this as a tale of utter woe. Even if countries can get their debts under control they face years of very slow growth.
You could even say that all the efforts of national governments, the European Union, the International Monetary Fund and so on to bail out the weaker countries merely piles on more debt and prolongs the agony, and there must be some truth in that.
But I think the more measured response is to note that while deleveraging always takes time and is unpleasant while it happens, it is a necessary process that creates a base for sustained growth in the future.
McKinsey looks at the experience of Sweden and Finland in the 1990s. Both had painful adjustments from credit bubbles. Both after 10 years or so both had got debts back under control and were experiencing sustained growth.
McKinsey notes that it will be harder for the western countries this time as the explosion of credit was more widespread. But I think we all knew that anyway, didn't we?
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