Debt Statements

When i first saw this chart (late last year) it made me blink. Then i forgot about it.

Fitch’s recent revision of it’s UK outlook (zerohedge) put it front of me again. Despite the obvious madness of basing anything on the fiction that is GDP, taken at face value, this chart says some interesting, if not shocking, things:

  • total UK debt (as a percentage of GDP, just imagine i’m saying that after each of these statements…) is roughly twice the level of the EU zone average
  • government debt in Japan is just insane, nobody even comes close to this level of madness
  • Sweden?! Norway?!?! What is going on there?
  • household debt in the EU zone is significantly lower than it’s G10 peers. Wonder where the likes Brazil will fall on this scale?

However, the obvious ‘elephant in the room’ is the debt of the UK financial sector. If it was still possible to imagine a rational financial sector in the UK, one might hope that the debt was money being put to use for productive activities. Of course such musings are now impossible, and we know that it’s propping up a mountain of badly made wagers, using strategies that really only insured that bonus criteria were met, regardless of the long term consequences.

Yes, it’s possible to argue that this wasn’t (isn’t?) universally true, but the aggregate result pretty much negates the need to further debate. They gambled, and lost. Given the propensity of successive UK governments to socialise these losses, the distinction between Government and Financial debt is increasingly blurred.

The continuing failure to regulate, or even attempt to moderate, the sectors excesses means that this debt will hang like a slow burning tire around the neck of the UK for decades…


30 year bondBeen watching this graph recently – it has been behaving badly…

That’s the yield on the US Treasury 30 year Bond. You can see the yield being forced down 2%, to 2.5%, from November to the end of last year. Then it creeps back up to 3.5% over a period of several months, where it stabilises until mid-April. At which point it starts to slowly, relentlessly creep back up. All of which raises some interesting questions, like ‘what’s happening?!’, and ‘what does it all mean?!’.

That graph shows the interest rate (yield) that the government has to pay on it’s debt. The more worried that ‘the market’ is about the amount of money that the Treasury wants to sell, the higher this yield moves.

Which would be simple, but of course, things are never allowed to be simple. In order to have some control over the rate, the Federal Reserve (central bank) can print up some new money, and buy the debt from the Treasury.

Unfortunately this ruse doesn’t appear to be working, as you can see – the rate is moving up. How can this be? Surely the Federal Reserve is so powerful, in theory being able to print an unlimited amount of money, there should be no limit to the scope of it’s action.

The problem for the Fed is that the more money that they print, the more the damage the value of the currency. The more they damage the value of the currency, the higher they would be forced to push interest rates to protect it. Not doing so risks crashing the currency, which when we are talking about the dollar is a big deal. The world holds trillions of dollars in reserves, and would not take kindly to having it rapidly devalued.

Another option is to squeeze money out of the equity / stock markets. Money exiting the stock market, seeking safe haven in the bond markets would help stabilise the yield. Or at least that’s the theory… in  my mind it doesn’t really work, or to the extent that it does, is of marginal effect. Someone holding stock decides to sell it, and move the funds into treasuries. For this to happen a second party must be on the other side of the transaction, and buy the stock. Where is the extra money coming from?

It’s possible to argue that the extra money is cash that is sitting on the sidelines (Sideline Cash Myth) but this doesn’t seem to stand up to much examination.

It seems to me that this puts us back in our usual position: between a rock and hard place. On one hand the government needs to finance debt in order to attempt to stimulate the economy / compensate for all the money being destroyed as debts go bad, interest rates need to stay low to keep this debt affordable, and reduce financing costs. And on the other, the currency needs to be protected or the market will not be willing to buy the the additional debt due to low yield, and fears of default.

Therefore the governments of the west are attempting to keep the system ticking along in the hope that enough growth will return to allow the debts to be paid down. At this point in the cycle, the debts are so huge that, i believe, this is no longer possible, or is at best, extremely unlikely.

Keep an eye on that graph. Nothing radical is going to happen now, but i suggest this is how you’ll know who (the central banks or the markets) is “winning” the war.

As an aside, a lot of this talk is about the dollar, but that’s mostly because it the easiest set of data to work with. The same situation is playing out in the other western economies, and the various central banks are fighting the same battle. The interesting exception to this rule, as always it seems, is the Bank of Japan, which despite printing money like it’s going out of fashion, has kept the yield on the japanese long bond remarkably stable. Again, as usual, i don’t understand the mechanism by which this can be explained…