Wednesday, November 24, 2010

Just How Scared Should We Be?

Sorry kitty

Could it happen here? When the markets have finished their sport with Ireland, Portugal, Spain, etc, will they turn on us?

Let's compare our situation with Ireland's.

Both of us have governments that are currently borrowing far too much. Theirs is a bit worse than ours, but setting aside this year's extra binge to bail-out their banks (equivalent to an eye-watering 20% of GDP), they're not that much worse. According to the OECD, even before today's emergency cuts, they were already planning to cut their borrowing to 7.4% of GDP by 2012. Which compares to the 6.5% planned by George.

Both of us have governments that went into the Crash spending unsustainable tax revenues built on unsustainable debt-fueled booms. And both of us have governments that were already carrying far too much debt when the crisis broke - in fact at end-2008, HMG's debt at 57% of GDP was actually higher than Ireland's 48%.

But the most worrying parallel is that both of us have governments that have written open guarantees for banking systems that are big enough to take us all down.

The key risk - as we've blogged many times - is that the banks' assets may well be worth a lot less than it says on the tin. Everybody is now acutely aware of that possibility, so without a taxpayer guarantee (implicit though it may be), any of the banks could face a run on their deposits and other sources of funds at any time. Which would break them. And quite possibly us as well.

But as we've just seen with Ireland, taxpayer guarantees only work if the markets retain confidence in the government's ability to deliver on those guarantees. And when you have taxpayers guaranteeing bank debts that are a multiple of their own incomes, that confidence is not something anyone should depend on for very long.

You see, a key point to remember is that the very same taxpayers who are having to service the government's debts, and guarantee the banks' debts, are also having to service their own personal debts as well. Which is one hellavalotta debt.

One widely used measure of overall indebtedness is an economy's total gross external debt - ie all the debt owed by all domestic entities to foreigners.

When last sighted (June 2010), Ireland's gross external debt was $2.1 trillion. Now, that is a serious liability. It is getting on for 10 times Ireland's annual income. It's like you having a mortgage of ten times your income secured on a row of unfinished estate houses in the middle of a peat bog.

And our own external debt?

Well, actually it's only $9 trillion. Which comes in at a "mere" 4 times our annual income.

Phew. We can all relax.

Er, nooooo.

Ireland may be in much worse shape than us, but compared to our major league competitors we are still in pretty bad shape. Germany's external debt stands at 1.4 times annual income, and the US is on less than one times. Japan - the country that people are always telling us has much more debt than us - is on less than 0.5 times.

Even more shocking, we are in worse shape than either Portugal or Spain - the two piigy countries now in the market firing line.

Here's the chart:

And that's why we can't relax. We may be in better shape than the Irish, but compared to other major economies we are right out on the thin ice.

True, we're not in the Euro, so we're not completely stuffed (as today's encouraging export news underlines).

But we can't devalue our way out of this debt for one very simple reason - a large chunk of it is foreign currency debt (eg see this blog).

How scared should we be?

It's at least an 8.

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