Recently we looked at the critical chart in sovereign debt analysis which painted a broad picture of how vulnerable sovereigns are to rises in interest rates. Well, today we thought we’d show you a couple of charts that should be paired with it. By the end of this piece you’ll have a good idea of the average debt costs that would detonate the accounts of major governments around the world.

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When looking at central bank balance sheets lately it’s easy to conclude that your portfolio should anticipate imminent cost-push inflation. After all, if you chart the major central banks’ balance sheets they’re all up and to the right like never before. Well, although this is a remarkable period in history (that may well see relentless inflation and/or sovereign default), it is not without precedent. If you go back far enough you’ll find that the world has experienced this type of environment before… and that the inflationary consequences of monetized fiscal deficits occur only over time. In order to give you a broad view of this subject, here we chart the history of the Bank of England’s balance sheet from 1844 to the present day.

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As some of you may know, I’m a big fan of Gustave Le Bon’s books; in particular I like The Crowd: A Study of the Popular Mind. I reread it (again) last week and was delighted to uncover some insights that I had not recognized fully before. So I thought I’d share some of them with you because I think that a sound understanding of crowd psychology is really useful for constructing or refining your investment process.

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Most people look at debt-to-GDP ratios when thinking about sovereign debt. It’s a good measure, but there’s a better one that goes for the jugular; the ratio of public debt to government revenue. By changing the denominator in this way you get a direct feel for how increases in interest rates affect government accounts. For example, when public debt is 10X government revenue then a 1% increase in the average interest rate paid on public debt forces the government to use an additional 10% of its revenues for paying interest. In short, this metric gives you a clear idea of just how easily a government could reach the keynesian endpoint (i.e. the point at which all of government revenues are used to pay interest alone).

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[EDIT: For up-to-date real interest rate charts see here.]
 
One of the most important themes over recent years has been the presence of negative real interest rates in the developed world. Whether one likes it or not, it has a big impact on how institutional money is allocated. Professional investors, who are under constant pressure from clients to make money, feel compelled to chase market momentum, especially when their clients’ money is slowly withering away because of negative real rates of interest. As Jeremy Grantham puts it:

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