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Running costs

Staying alfloat in a high-maintenance world
August 16, 2018

You’re probably estimating what it costs to live my gilded lifestyle in central London. Not that you’d be in the least bit interested, but I really do have fairly simple tastes. I’m talking about running the country – and its borrowings, to be precise. Latest data for Q1 2018 shows UK sovereign debt stands at £1.78 trillion, or 86 per cent of GDP. Servicing this cost £48 billion over the fiscal year, equivalent to 4 per cent of GDP. Cumulative debt is a lot higher than the average 43 per cent debt/GDP since 1975, and four times the 1991 low point of 21 per cent.

It’s not quite as terrible as you might think, and compares with 175 per cent post-WWI, 240 per cent post-WWII, and 250 per cent after the Napoleonic wars. What is unusual is that one-third of bills and gilts outstanding are owned by the Bank of England courtesy of quantitative easing. What is also interesting is that despite the large absolute and relative amounts of paper outstanding, gilt yields are still close to their record lows – 0.75 per cent for two-year (where they have been most of the time since 2008), 1.25 on 10-year (since 2016), and similarly 30-year at 1.75 per cent. Were these interest rates to double, but on the whole keep lower than US ones, servicing the debt would increase to almost £100bn – not quite the NHS’s current £125bn, but not far off.

 

In Japan, the nation with the highest debt ratio at 240 per cent and almost as high as 1945’s 266 per cent (despite being at peace since then), debt servicing costs are next-to-nothing because Japanese government bond interest rates are zero out to 10-year paper, and the unpopular 20-year series yields just 0.6 per cent. More debt, yet less cost; one to ponder.

Italy, where total outstanding government debt is a record €2.327 trillion, has a ratio of 133 per cent to GDP – and rather frighteningly the black market economy is included, and amounts to an estimated 20 per cent of national output. Here borrowing costs have risen considerably since May’s general election, 10-year BTPs yield 3 per cent, as do those in the US. Chart patterns on these suggest they could go a lot higher – and suddenly. It’s bad enough as it is because Italy pays 10 times the 0.3 per cent interest costs on German 10-year Bunds. Sustained differentials like these are crippling. Argentina, which raised its key rate to 45 per cent this week, will once again find this out the hard way.

 

Spain, one of the worst serial defaulters since they started funding the Spanish Armada and sundry wars, today has a debt-to-GDP ratio of 98 per cent. It’s often lumped along with Italy, Greece and Portugal, the Mediterranean children on the naughty step. However, current yields on 10-year government Bonos are just a whisker from 2016’s record low, a descending right-angled triangle, suggesting they could drop another notch towards 0.5 per cent.

 

The US yield curve is as flat as a pancake, the longer end of the spectrum pretty much ignoring Fed Funds rate rises; this is often a portent of looming recession. You must admit that, when a 10-year investment yields just 15 basis points more than two-year paper, and extending this for another 20-years adds a mere 15 basis points again, something is seriously wrong.